Genworth Mortgage Insurance Investment Thesis
GMA is a single line insurance product company. The only insurance product it sells the lender mortgage insurance (LMI).
LMI is an insurance contract that protect lenders from borrower defaults. In the simplest sense, in event of borrower default. GMA pays the difference between the realized sale value of the property and the loan to the lender while the borrower actually pays the premium as condition for the bank to approve the loan.
Against common perception, LMI is designed to protect the lender in event of borrower default not the borrower.
Genworth Mortgage Insurance is an interesting cigar butt idea where the GMA share price is trading below book value. The company has been aggressive in returning capital to returns either through fully franked dividends or share buyback.
As with everything in investment, there is not such thing as a free lunch. The discount to balance sheet can be attributed to a number of factors:
Key reasons for GMA discount to Net Tangible Book Value
Key Customer Risk
The company is overly reliant on the Australian banks as key customers. Its major customers could become major competitors over night if they choose to internalize the LMI book in house or in the instance of Westpac, losing a key customer.
Other large LMI insurance in Australia includes QBE Insurance (QBE ASX)
Residential Market Slowdown
Investing in GMA is taking a view on the future trend on residential house prices. GMA share price today is partially pricing in a potential housing slowdown. As Genworth Mortgage Insurance is a single line insurer. Its earnings are pro cyclically and leveraged to the performance of the housing sector.
It is essentially a feast and famine business where its earnings are boosted when markets are good and extra depressed when bad. The goal of income from unearned premium on the balance sheet is to smooth out this cyclicality however the low interest rate environment is not helping.
GMA coverage is spread across Australia. The insurance book is still concentrated in key states of New South Wales, Victoria and Queensland. The risks in slowdown in Sydney and Melbourne house prices which make up a large portion of its business will have adverse affect on GMA’s value.
Chart below shows the run up in house prices in the last 4 years. It is clear that the growth in residential house values in New South Wales and Victoria have been above system growth. (see our Sydney property market forecast)
Source: ASX GMA
The key question is if it can withstand keep the business standstill and run off the current policy book in run off mode and ride out the cycle. Or give in to pressure from earning driven investors and keep writing policy on inflated house values at the current point in the cycle.
Current FY16 guidance sees Net earned premium down 5% but this is driven by the loss of a key customer Westpac.
Chart below shows the trend of delinquency by vintage over the last 10 years. Deteriorating underwriting standards from the 2007 and 2008 years really showed during the GFC.
Source: ASX GMA
Credit goes to APRA and current banking lending standards that level of 90%+ LVR lending has been drastically reduced. Chart below shows the origination have predominately focused on the 60% to 80% LVR range.
Key Shareholder Risk
GMA is 52% owned by US based Genworth Financial (GF). Genworth Financial (GF) is fighting for its life in the US given issues with the long term care insurance business. We consider the accelerated rate of capital return driven by GF requiring capital given it has $600 million USD debt due in 2018. It will even consider an on market buyback in the near future.
As the prior written polices expire, capital is free up and the management have been proactive in returning to share holders. Additionally it has been taking reinsurance polices so capital can be freed up faster. Note that reinsurance comes at a price.
But is the accelerated return of capital to the detriment of the business in the long run? The risk is if capital is returned and the book value deteriorates faster than expected if there is a downturn in housing markets then business will be under capitalized. However this is not our base case.
The issue we see with GMA is that it need to take short term pain and avoid writing policies at this point of the residential real estate cycle. The question becomes if it can.
GMA Dividend Dates 2016
Final Ex-Dividend Date: 21 Feb 2017
Final Record Date: 22 Feb 2017
Final Dividend Payment Date: 08 Mar 2017