Tag: MIC

Genworth MI (TSX: MIC) reported their 4th quarter and year-end earnings yesterday.

I have been covering Genworth MI since 2012. While I liquidated a significant portion of the company in 2014, as a result of the price depreciation exhibited over the past three months I have taken the liberty to once again make MIC the largest position in my portfolio (at prices from 22 to 25 a share) as I believe it is trading well below my estimate of their fair value. Companies trading at a discount of over 1/3rd of their tangible book value and at a P/E of 6 either are fraudulent (which is clearly not the case with Genworth MI) or have external sources of perceived stress causing such an intense discount.

Financial Statement Review

I will pick off some salient details of their report.

1. From year-to-year the balance sheet saw an increase of about CAD$450 million of real assets (cash, bonds, preferred shares, common stock) relative to the end of 2014. Roughly half of this was through an increase in deferred premiums (money collected for mortgage insurance that is held on the liability column of the balance sheet until it is recognized as actual revenue in accordance to a model for historical loss experience) and a good chunk through retained earnings.

2. Premiums written were up to $809 million for the year, compared to $640 million the year before (a 26% growth). You can thank the CMHC for this. Alberta went down from 26% in 2014 to 22% in 2015.

3. They continued to add to their preferred share portfolio; they sold their common shares and moved to preferred shares, which is still sitting on an unrealized loss position of $33 million on a $281 million cost base; this is better than Q3-2015 which was $42 million unrealized loss and $236 million, respectively. Given the existing valuation state of the Canadian preferred share market, shifting to preferred shares is a value-added decision especially when considering the positive tax consequences of inter-corporate dividend income for insurance companies. 92% of their portfolio is rated “P2” and the remainder is “P3”.

4. The company repurchased $50 million of shares and outstanding shares is down from 93.1 million at the end of 2014 to 91.8 million on December 2015.

5. The company’s debt maturing in 4.5 years has a yield to maturity of roughly 3.5% (traded at 109 cents on the dollar at year end). Their maturity at 8.25 years out was trading at a very slight premium and is YTM 4.2%. Back on November 6, the company was exploring a debenture offering. Their cost of raising debt capital seems to be relatively low, so it is curious why they never proceeded with it.

6. Delinquencies have not materially picked up in Q4-2015 (rate still is 0.1%).

7. Minimum capital test ratio goes from 227% to 233%. Management has pledged repeatedly that their target is “modestly above 220%” in terms of capital management. It is getting to the point where they will likely execute on another share buyback, and considering the huge discount to book value, they should consider a dutch auction at around CAD$25 to get those shares very cheaply off the books instead of dealing with a thin marketplace (recognizing that Genworth Financial owns 57% of the shares outstanding). As they have 13% in excess of 220%, this translates into about $203 million in excess capital.

If they managed to buy back 8 million shares for $200 million, they’d be able to increase book value by over a dollar a share! At existing valuations it would make complete sense for them to go private, but since Genworth Financial is facing huge financial challenges, they’re not the entity that is going to do it. This is a contributor to the depressed share price of Genworth MI (the market knows that Genworth Financial is facing pressure to sell the entire asset for a pittance).

8. The company expects lower amounts of mortgage originations in 2016. This will negatively impact premiums written in 2016. They did take 4% market share from CMHC in 2015, however, which may offset the decrease in originations.

9. Loss ratio is expected to be between 25-40%, which is more than the 20-30% guidance given for the 2015 year. Loss ratio guidance has always typically been conservative in nature. Considering the combined ratio for 2015 has been around 40%, an extra 10% on the loss side would put it at 50% and thus not anywhere close to endangering the profitability of the company.

Extra thoughts concerning valuation

Stated book value per diluted share is $36.82 – this is 35% less than the current market value of $23.91/share. If the company continues to book premiums written at $800 million in 2016 and maintain a combined ratio of 50% (30% loss, 20% expense), this would still be quite an undervalued entity.

I see two issues of market price stress:

1. The perception that the Canadian housing market will collapse and cause a huge wave of defaults which would bring mortgage insurers down like what happened in the USA in 2008;

2. Parent Genworth Financial’s issues spilling over onto Genworth MI – Genworth Financial needs money out of their subsidiaries and the trickle-down effect of dividends will not cut it for them. They can consider capital transactions (share buybacks) and keep their proportionate stake which enables them to bleed money out of the company at an accelerated pace, but this would still not be adequate for their situation. The market is likely taking the MIC subsidiary down in value on the implied assumption of a fire-sale of the 57% stake in the company. Of course, Genworth Financial would have to be completely desperate to do it at a 35% discount to book value (not to mention a P/E of 6), but the question here would be: Would they be willing to sell the whole thing at book?

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!

Genworth MI (TSX: MIC) recently disclosed that they repurchased 1,454,196 shares in mid-May for roughly $34.38 per share, a repurchase representing $50 million.

The buyback algorithm they employed was less than subtle, mainly the repurchase of 137,210 shares per day for 10 days and 82,096 shares for the last day. As 57% of the shares outstanding are owned by Genworth (NYSE: GNW), they supplied 57% of the liquidity for these transactions. 620,818 shares were taken out of the public float.

This repurchase was executed at slightly less than book value, which means it will be mildly beneficial to book value per share – my estimates are that based off of end of Q1-2015, the transaction would add 3 cents of book value per diluted share.

Of course, the transaction will be hugely accretive to earnings – the buyback represents 1.56% of shares outstanding, which means this will add a couple pennies a share to the quarterly EPS figures. In addition, the buyback also means that the company will not have to give out an extra $2.3 million a year in dividends.

At the end of Q1, the company had $200 million in surplus of its own internal buffer, which is 220% of the minimum capital test required to operate. The company reported 233%.

As the company typically book about $90 million in income a quarter, the buyback likely represents a “cash neutral” policy of balancing dividends (est. $36 million in this upcoming quarter) and share buybacks, at least with its current market value. If their market value remains suppressed below book value and they keep executing buybacks on a quarterly basis, I foresee higher equity prices in the future.

Long-time readers here will remember that I disagreed strongly with management’s decision to repurchase shares at $40/share back in 2014. May 2015’s repurchase I completely agree with – a shame they could not execute it in March, but still, they (and shareholders) will receive good value for this $50 million repurchase.

I continue holding Genworth MI shares since mid-2012.