Tag: MIC

Canadian housing stats vs. Mortgage Insurance

Genworth MI (TSX: MIC) has taken a hit over the past three weeks due to statistics that housing sales and average prices are declining nationally, according to a CREA report. Another sensationalist headline (“Canada’s average home price drops over 10% year-over-year in March”) is here.

Genworth MI stock rose in the month of March partially due to the company going on a buying spree on a stock buyback – it bought back 1.2 million shares. Other than that, there has been consistent selling pressure.

The report cites the impact of the B-20 regulation from OFSI, which increases the qualification criteria for people to obtain non-insured residential mortgages.

There are two factors here as it relates to Genworth MI that are being confused: 1) the pool of potential insurable mortgages, 2) what exactly the implication of average pricing statistics entails.

Aggregate Statistics

What market participants are failing to understand is that statistical averages fail to capture the economics of the mortgage insurance market, even in a declining average price environment and are probably taking down the stock due to incorrect reasoning (which usually leads to an environment where the stock will be undervalued).

The national housing price statistics are dominated by three regions: Toronto, Montreal and Vancouver. The “right-side tail” of the distribution of housing prices in the Toronto and Vancouver markets (especially in single-family residential) are dominant factors in statistical mean pricing. For instance, if your housing market consisted of a $3 million house, a $1 million townhouse and a $500,000 condominium, a 10% decrease in the house price would dominate over a proportionate decrease in the townhouse or condominium price, due to price weighting.

Vancouver is an extreme market, partially due to the huge influx of foreign capital buyers, which the government is actively trying to curtail. The 95th percentile of the real estate market is dominated with speculation from foreign (mainly people connected to Mainland China) buyers and asking prices have been decreasing in the hundreds of thousands of dollars for single family dwellings in the Metro Vancouver region. I have been paying less attention to the Greater Toronto Area, but apparently there is a similar mechanic going on there.

As a result, when speculation moves the 95th percentile market, it will result in massive price swings that have powerful effects on aggregate mean statistics. There is a “bubble-down” effect on the remainder of the real estate market, but this is more diffuse and domestic demand for lesser priced properties serves as a buffering effect for the absolute decline (not percentage decline) in those prices. It pays to longitudinally study properties that are in the 50th percentile (i.e. using median statistics) as a more intuitively accurate grasp of what is going on. These usually aren’t published.

Mortgage Insurance Eligibility

Keep in mind that properties over $1,000,000 are not eligible for mortgage insurance. Secondary residences in Vancouver, Calgary and Toronto are up to $750,000. (Good luck with this amount in Vancouver!).

Net Impact to Genworth MI

The only impact I would expect from what is happening in Vancouver and Toronto is that less mortgage insurance will be written – this is derived from the decrease in re-sales of real estate. The quality of the underlying insurance portfolio will also exhibit a higher loan-to-value ratio as prices normalize, but as mortgage insurance services the more “retail” element of real estate purchasers, I would expect them to continue paying their mortgages and amortize the existing debt amounts – 15% of the debt is amortized in 5 years with a typical 25 year amortization period and 3% interest rate. Employment is a much bigger driver – I would worry if unemployment rises.

Genworth MI will report the first quarterly report in late April or early May – I would continue to expect to see very good numbers posted with respect to loss and severity. Book value should also creep up another 60-70 cents per share, which would bring it close (but not quite) to $44. At the current price of $39, they are trading at a moderate discount.

Genworth MI – Q4-2017: Capping off a very profitable year

Genworth MI (TSX: MIC) reported their 4th quarter results today. For those new here, I’ve been freely covering this company for ages. It is the stock in my portfolio I have held for the longest period of time (since 2012). It has sometimes been the highest concentration position in my portfolio, but it currently is not. Here are some notes:

1. The big headline-grabber should be the loss ratio. It is still exceptionally low (9%) – reflecting a relatively stable real estate climate. The average loss ratio for the fiscal year was 10%. This is at a record-low level.

Let me put some context to this. The loss ratio means that for every dollar of insurance the company recognizes revenues on (note this not the insurance they write in a given year although the two numbers are correlated), that the corporation books 10 cents on the dollar of expenses because they have to account for losses on insurance claims.

This means for every dollar the company recognizes, they retain 90 cents, before other expenses.

The expense ratio is 20%, which means it costs 20 cents on the dollar to administer the insurance (e.g. commissions paid to acquire the policies, the administration of claims, management, etc.).

So what is left over is 70 cents on the dollar.

From this pool of money, the two big expenses left to be paid is interest on debt and income taxes. $24 million was booked for interest expenses (about 3.5 cents) and $188 million (28 cents) was booked for the year in income taxes.

However, (this is where readers of Warren Buffet’s annual reports will know this on the back of their heads), Genworth MI has the benefit of float, which is the 6 billion in assets they have to invest before they pay out claims. As a function of premiums recognized (revenues), Genworth MI made 39 cents on the dollar with their investment portfolio.

So when you do the math, the company recognized $676 million in revenues, and recorded a bottom-line amount of $528 million, or 78 cents on the dollar of net profitability.

I want anybody to tell me any other company on this planet earning 78% net margins, after interest, depreciation/amortization, and taxes.

When people are paying their mortgages, this is a wildly profitable industry to be in.

This breaks when people start defaulting on mortgages, causing a collapse in real estate pricing due to forced liquidations, and then soon mortgage insurance providers will be hard-pressed to pay banks that will be knocking on the door. So far, this scenario has not happened. A rising real estate price environment means that even when people default on their mortgages, when they occur, such defaults are not severe from a mortgage insurance perspective – even when there is fraudulent underwriting (see: Home Capital Group).

The Canadian government is most unlikely to change this insurance scheme, because the 100% government-owned crown corporation, CMHC, is also raking it in – their volume is roughly double of what Genworth MI does. Why interrupt the gravy train when this crown corporation is delivering huge amounts of cash to the government in the form of mortgage insurance fees?

2. Premiums written on transactional insurance was up slightly from Q4-2016 – mainly due to the increase in mortgage insurance rates from last year, offset by decreased volume due to mortgage rule changes. Portfolio insurance is down significantly, but this was expected due to regulatory changes. My take on this is that it appears that the dollar amount of insurance written has stabilized. There is slightly less concentration in Ontario/BC than the rest of the country:

3. The interest rate swap they took to the tune of $3.5 billion notional value 3-5 years out continues to pay off – fair value of $131 million at Q4-2017 vs. $120 million in Q3-2017. This was a very, very smart move on interest rates.

4. In terms of balance sheet management, the only changes to the portfolio has been a slight shift away from corporate debt, in favour of collateralized loan obligations and an increase in corporate preferred shares (5-year rate resets). Fair value has increased to $6.45 billion from $6.34 billion.

5. It is still not entirely clear what the impact of the China Oceanwide merger with Genworth Financial (NYSE: GNW) will be – or even whether this merger can be consummated at all. Reading Genworth Financial’s 8-K, a huge stumbling block is “The delay in the review process is due to the difference in opinion of the fair market value for Genworth Life and Annuity Insurance Company (GLAIC)” which is a huge stumbling block (this subsidiary of Genworth Financial is saddled with liabilities concerning the long-term care insurance pricing disaster). One potential scenario has always involved Genworth Financial completely selling off their holdings of their Australian and Canadian mortgage insurance subsidiaries.

Genworth Financial is also looking at a secured bond transaction to finance their upcoming 2018 bond maturity – although they have the cash at the holding company level to pay it off, it will leave them constrained.

6. Minimum capital test level is at 168% with the target being 160-165%. Management has a history of either executing a share buyback or giving out a special dividend with the excess capital. Their history has typically been quite prudent and only buying when the stock is at a substantial discount to book value – which it is not presently. I would believe they will be holding tight and figuring out what to do with the excess capital later. Diluted book value is $43.13, while the common stock closed today at $41.49.

(February 7, 2018: Listening to the conference call, I believe management will let the MCT go substantially higher than 165% during 2018 – I no longer believe a share buyback or extraordinary dividend will be in the works in 2018).

(April 9, 2018: My February 7, 2018 note was obviously wrong – the company bought back 1.2 million shares in March at around $41/share).

The company remains in what I consider to be my fair value range at present.

Genworth MI’s slow ascent

Genworth MI (TSX: MIC) reports their third quarter earnings on Thursday.

The stock has been on a mild uptrend as of late:

I suspect in absence of anything material in the Canadian real estate market, that the upcoming quarter will be financially positive and the market has already anticipated this.

Genworth MI is also likely to announce an increase in their quarterly dividend. They also executed on a modest share buyback in the previous month.

Probably the biggest amount of uncertainty would come from the parent company, Genworth Financial (NYSE: GNW) where it is not apparent whether their merger will receive sufficient authorization from the federal government authorities to proceed or not. Because they have an upcoming US$600 million debt maturity in May 2018, things are getting a bit tight financially – while their holding company does have around $800 million to work with, an analogy after $600 million of that goes to pay the debt would be like running the automobile with no bars of gasoline left on the tank gauge.

Their 10-Q states, “In the absence of the China Oceanwide transaction or in the event we are unable to refinance our debt maturities, we expect we would be required to pursue asset sales, including potential sales of our mortgage insurance businesses in Canada and Australia and/or a partial sale of our U.S. mortgage insurance business to service our holding company debt.”

Will Genworth MI be sold? It would be an easy US$1.6 billion for them or more depending on how much of a premium they receive…

Genworth MI buying shares again

Genworth MI (TSX: MIC) filed with SEDI last week that they executed a share buyback in the month of August, purchasing approximately 913,000 shares at roughly CAD$36/share. This is nearly 1% of their shares outstanding. In light of the fact that they were making rumblings in filings a year ago with respect to the adverse consequences of increasing capital requirements with respect to the OSFI policy changes, this is most definitely a signal that they are now in an excess capital situation. The share buyback is at a discount of 13% to book value, so management cannot be accused of wasting value with this purchase (a rare characteristic that I very rarely seem managements of other companies perform when they conduct share buybacks).

Finally, Genworth MI traditionally increases its quarterly dividend rate in the third quarter announcement or announces a special dividend. The current regular quarterly dividend is likely to increase from 44 cents a share to around 47 or 48 cents. Management has a good track record of prioritizing buybacks when the share price is depressed to book or giving out special dividends when the share price is relatively high – I do not view a special dividend as being likely. Although my Genworth MI position is smaller than it used to be in the portfolio, it is a significant equity holding of mine and I see no reason to sell at this juncture, in absence of other opportunities.