Genworth - A Shorting Vehicle?
In May this year Genworth Mortgage Insurance Australia Limited (ASX: GMA) finally completed its initial public offering (IPO) of 220 million shares at an IPO price of $2.65 per share.
The stock is relatively speaking a little tightly held, with Genworth Financial Inc. retaining 430 million of the 650 million ordinary shares representing a 66.2 percent ownership, while institutional investors account for most of the rest - the Top 20 shareholders of GMA hold all but 7.8 percent of the 650 million ordinary shares on issue.
Genworth in Australia (GMA) is a monoline lenders mortgage insurance (LMI) insurer and with a 44 percent share of the Australian LMI market it has been perceived by many to be the ideal shorting vehicle for Australia's long-suffering housing market bears.
While Australia's major banks are somewhat diversified, gross written LMI premiums are essentially the whole of Genworth's Australian business, and as such GMA is a "cleaner" proxy for mortgage delinquencies and thus related housing market sentiment.
A Walk on The Short Side
A Walk on The Short Side
While the percentage of total issued capital being sold short will not run high due to the group's shareholding structure noted above, there has been some interest on the short side for GMA, although the data shows that there are currently many more shorters of embattled iron ore producer Fortescue Metals Group (ASX: FMG).
Share Price Action
So how are the shorters tracking? The over-arching answer is "not very well" since the IPO, with GMA's share price having ripped 26 percent higher from the initial offering price after strong reported underlying profits for H1.
There was a good deal of excitement from the usual quarters when Standard & Poors (S&P) announced a ratings downgrade for GMA to "A+ with a negative outlook".
Being classified as an "insulated subsidiary" of the Genworth group, under S&P's existing rating methodology GMA must be capped at only a three notch differential from the group's component member Genworth Life Insurance Co. (GLIC), which itself had been downgraded to "BBB+ with a negative outlook" following the release of Genworth Financial's earnings.
As such, the downgrade in GMA's rating was not directly related to its own capitalisation nor to Australian mortgage delinquency rates, a point predictably misunderstood in Australia.
GMA - Q3 results
GMA released its Q3 2014 results on November 6 and in respect of the Australian group reported a third quarter Net Profit After Tax (NPAT) of $64 million and a year to date NPAT of $215 million as at 30 September 2014.
It was a strong set of results with Gross Written Premiums up by 5.3 percent on the prior comparative period to Q3 2013, and NPAT up by 13 percent (profit before tax is up by 8.8 percent).
Delinquency Rates Decline
Of course, analysts of a monoline insurer are at least as interested in mortgage delinquency rates as they are in the volume of premiums written, and the results were solid here.
Since the 2009 book year, the level of new delinquency rates has fallen substantially lower and this continues to be the case in the most recent book year.
The number of paid claims of the past seven quarters has declined considerably from 722 to only 350, slashing net claims incurred in half over the same time horizon.
Regular readers will know that we do envisage potential problems ahead for some mortgage holders.
In South Australia and in regional Queensland in particular, where a weak economy and a troubled coal sector are biting respectively, we do see some risks of elevated delinquency rates.
Indeed rates of delinquency have already run notably higher in Queensland (0.49%) and South Australia (+0.43%) than elsewhere in Australia, but thanks to exceptionally low delinquency rates in New South Wales (0.30%) and Victoria (0.32%), the portfolio records a very low rate of Australian delinquencies in aggregate at just 0.36%.
We expect that the unwinding of the mining construction boom will have some effect too, although this may be cushioned to some extent by the lucrative remuneration packages that many employees and contractors have enjoyed through the construction phase of the boom.
GMA's delinquency rate of 0.36% is skewed higher by the troublesome 2008 book year.
However, since that time, mirroring the findings of Reserve Bank research (which revealed that the average mortgage holder is some 24 months ahead on mortgage repayments thanks to Australia's unique loan product structuring), delinquency rates have fallen consistently over the following 5 book years.
Low interest rates and low interest repayments are clearly helping homeowners, and mortgage stress is relatively speaking low at the present time.
Regulatory Capital Position (RCP)
Genworth's RCP is strong thanks to strong underlying performance since 2009 and the ongoing seasoning of old books.
GMA's earnings release figures reported a strongly capitalised position with a Level 2 solvency ratio of 156.4 percent (a prescribed capital amount or "PCA" ratio of 1.56x) and the company retaining "additional capital flexibility".
GMA also reports a strong balance sheet with $2.4 billion of net assets, a "highly rated" cash and fixed interest investment portfolio of $4 bilion, and a balance of $1.3 billion sitting in its Unearned Premium Reserve (UPR) account.
Just as in the way that "super-cat" insurers are priced by the market for the potential fallout from bad years as much as for what happens in the good, mortgage delinquency rates tend to be fine until they are not.
Such is ever the nature of housing market cycles, and in the post financial crisis era, not least because of the ever-present short sellers of such stocks, PE ratios on a stock such as Genworth Australia are unlikely to ever be elevated.
For these reasons GMA continues to trade at at a single digit PE ratio of a shade under 10.
Those with short positions will be hoping for further rises in the unemployment rate since Australia does not engage in widespread sub-prime lending (or even much "low doc" lending) and high interest rates are completely off the table as a cause of deliquencies for the foreseeable future.
A recent survey by Genworth showed mortgage stress to have halved while only 2 percent of surveyed borrowers were behind on repayments. although such these surveys are very small and shouldn't be relied upon much more than anecdotal evidence.
The beauty of GMA as a proxy for housing market sentiment is that market moves will be almost instantaneous and assuming that the market remains rationally priced, any forthcoming flood of delinquencies should be quickly anticipated and reflected in the share market.
Unfortunately for the shorters, GMA's performance has remained solid, reflected in the 26 percent increase in its share price over the past six months.
A skim through recent Statements on Monetary Policy (SOMP) confirms that regions which might be at the greatest risk of an elevated rate of delinquency include coal mining regions.
As Genworth Australia is 66.2 percent owned by Genworth Financial Inc. and with the "instos" mopping up much of the rest the market, GMA will be far from the most liquid market on the ASX.
Nevertheless, the GMA share price chart should act as an effective bellwether for expectations of non-performing loans and delinquencies, and thus analysts will therefore continue to scrutinise future price action with a keen eye.