A Safe Bet on Canada’s Housing Boom
06/07/2011 12:24 pm EST
Mortgage insurer Genworth MI has locked down 30% of a very healthy market north of the 49th parallel, writes Gavin Graham in The Income Investor.
Although the company was established in 1995, it has only been listed in Toronto since July 2009. That's when its US parent, Genworth Financial (GNW), sold off 42.5% of the company for $753 million (39.6 million shares at $19 a share) to repair its balance sheet after losses caused by the US housing crisis.
Unlike the US, Canada has not suffered declines in its housing market, owing to tighter lending standards and a stronger economy. That makes Genworth MI an attractive low-risk housing play—virtually regardless of whether house prices continue rising, stabilize (as Genworth expects for 2011), or even fall somewhat, as they did in 2008 and 2009.
Genworth MI is suitable for conservative investors looking for a defensive investment with a good yield. It is trading at about the same level as it was a year ago, despite a share repurchase, a higher dividend, and improved earnings.
Shares are priced at less than nine times forecast 2011 earnings, and only 5% above book value. The company has a solid balance sheet, a high-quality investment portfolio, and $2.6 billion in shareholders' equity.
Paying Benefits for Years
Mortgage insurance in Canada is a duopoly between the government-owned Canada Mortgage and Housing Corporation (CMHC), with 70% of the market, and Genworth, with 30%.
In 2010, Genworth wrote over $27 billion worth of new mortgage insurance. (All figures are in Canadian currency.) That generated $552 million of net premiums written, an increase of 53% from the depressed 2009 total of $360 million.
Because 50% of premiums are not booked as revenue until the second to fourth years after the year in which they are written, reflecting the historical loss experience of the mortgage insurers, Genworth has high visibility and predictability of earnings.
As a result, net premiums earned in 2010 were virtually flat at $621 million, against $610 million in 2009. This reflected the boom in low down-payment, 35- and 40-year mortgages from 2006 to 2008, before lending standards were tightened.
Genworth's loss ratio in 2010 was 33% (i.e. defaults were equal to one-third of its net premiums written), and its combined ratio including operating expenses was 50%. The delinquency ratio on its insurance in force at the end of December was 0.26%. These numbers were in line with the company's targets.
Genworth's minimum capital test ratio is 156%, well above the 120% required by Canadian regulators. Its $5.1 billion investment portfolio is made up largely of A or higher-rated fixed-income securities, has a short duration of 3.6 years, and a yield of 4.2%.
NEXT: Smarter Clients than the Average Firm|pagebreak|
Smarter Clients than the Average Firm
With 40% of mortgages carrying insurance, Genworth MI's target market of first-time buyers is:
- younger (aged 25 to 45)
- more conservative (as reflected in the high proportion of fixed-rate mortgages)
- buys cheaper houses ($287,000 vs. the market average of $340,000)
- and has a higher family income ($84,000 per annum vs. $73,000)
The income level is a result of the high proportion of dual-income families, which is often required to make home ownership affordable in urban centers.
The lower average home price drives a lower average mortgage ($245,000), which, when combined with the higher average family income, gives Genworth's book of business better price-to-income and debt-service ratios than the national average.
Losses declined from 42% to 33% of premiums last year, thanks to stronger employment and the recovery in house prices. Combined with $183 million in investment income, this helped net operating income rise 12%. Operating return on equity was 14%, up one point from the year before.
The company increased dividends by 18% in the fourth quarter, from 22 cents to 26 cents per share ($1.04 a year). Genworth borrowed $425 million to more effectively use its balance sheet, while its book value rose 7.6% to $23.27 per share.
Genworth plans to repurchase $160 million worth of its shares in 2011.
Good Changes, Solid Dividends
The economic situation has been marked by low—though modestly increasing—interest rates, improving employment, and stable consumer confidence.
Some prudent mortgage policy changes were made in March, such as the abolition of 35-year mortgages and insured home equity loans, and lower maximum loan-to-value ratios for refinancings.
As a result, Genworth anticipates average house prices will effectively be flat this year. Also, the size of the mortgage-insurance market may be reduced 5% to 10%, the company forecasts.
Some commentators anticipate a much more severe housing collapse in Canada, along the lines of the US, pointing particularly to the record house-price-to-income ratios in British Columbia. However, the value of Genworth's average mortgage there is 30% less than the provincial average.
The company has set a dividend-payout ratio of 35% to 40%, and its present payment of $1.04 annually is below the bottom of that range, at 34.6% of the $3.01 of operating net earnings.
After the 18% increase last year, it is reasonable to assume that there will another increase in the next year or so—but even if there isn‘t, Genworth yields 3.9%.
Mortgage insurance is a stable business with high barriers to entry and good predictability in earnings. The Canadian housing market experienced a 15%-20% fall in 2008-09, yet Genworth emerged relatively unscathed. The subsequent tightening of underwriting standards and mortgage lending regulations has made the industry less cyclical.