Genworth Mortgage Insurance (ASX:GMA) shares have fallen about 10 per cent in the last month. Are they now cheap enough to buy and does the chart indicate that this is a good level?
About Genworth Mortgage Insurance
Genworth Mortgage Insurance (GMA) is the leading provider of Lenders Mortgage Insurance (LMI) in the Australian residential mortgage lending market. It has an estimated market share of approximately 25% of the Australian LMI market, on the basis of New Insurance Written. An LMI helps lenders manage credit risk and is usually taken out on loans with a loan-to-valuation ratio (LVR) above 80%.
The Company’s major shareholder is Genworth Financial, who holds approximately 52% of GMA’s issued shares.
Key Investment Considerations
1. Earnings Impacted Following Review of ‘Earnings Curve’
In late 2017, GMA undertook a review of the earnings curve. This determines the proportion of premiums that should be recognised as revenue over the life of an insurance contract. The earnings review conducted late last year resulted in the average duration of the period over which GMA recognises revenue being lengthened by approximately 12 months. While this does not impact the total amount of revenue expected to be earned over time from premiums already written, the reported earnings for 1H18 showed a significant decline.
2. Potential for New Contract Opportunities
Genworth Mortgage Insurance has commercial relationships with over 100 lender customers across Australia. It provides LMI to 10 of its key customers major lenders via a Supply and Service Contract (SSC) that typically run for three years. As at FY17, GMA’s top three customers accounted for approximately 73% of GWP in 2017. Accordingly, the loss of a major customer is a major risk for the Company.
GMA has an existing LMI contract with NAB. There is an opportunity to secure a greater portion of NAB’s LMI work when the existing contract expires in November 2018. At present, GMA provides ~30% of the LMI on NAB mortgages, with QBE providing the balance.
Should GMA be successful in winning new contracts, GMA is likely to have sufficient equity capital, supported by new reinsurance and qualifying debt, to support the capital requirements from new business. Further, premiums would likely increase, which is turn boosts profitability.
3. Impact from Macro Factors Likely Neutral
GMA is experiencing revenue pressures from regulatory pressures that are reducing the number of high LVR loan originations. At the 1H18 results release, GMA commented that it expects the moderating trend in housing market conditions, which has been underpinned by pressure on lending as a result of macro-prudential measures, tightening credit standards and record levels of new housing supply coming onto the market, to continue.
The Company indicated that a gradual fall in house prices can be a positive. This is because it will attract more first home owner-buyers to the market with LVRs of 90%, which is a core target market for the Company. However, the flip-side to this strategy is that having a greater portion of +90% LVR loans on its book potentially increases the future rate of delinquencies should a downturn in the housing market continue, or be more severe than initially expected.
4. Surplus Capital Supports Further Capital Management Options
The Company currently holds surplus capital above its regulatory solvency ratio, which is expected to support further capital initiatives. This includes being able to maintain a high dividend payout ratio of 50-80% of NPAT and undertaking an additional $100m share buyback in FY19 once the current $100m share buyback that commenced in May 2018 is completed.
Fundamental View of GMA
Earnings over the short term have become harder to predict, given the earnings curve revision in FY17, new business initiatives entered into in 1Q18 and an increasing loss ratio, including softening cure rates (i.e. the portion of bad loans that reverse). Notwithstanding, GMA is starting to look like better value at these lower levels. This is in light of the potential for capital management and potential earnings uplift from new contract opportunities.
Technical View of GMA
During the second quarter of this year, GMA shares were looking fairly positive. However, they reversed sharply in August after hitting resistance near $2.90. They are now sitting at some minor trendline support. If the shares can bounce strongly from here, then that would mean that they are going to have another run towards that $2.90 level for another retest. Otherwise, weakness from here would mean that they are going to head the other way, retesting support near $2.20. Price action for GMA is therefore worth watching over the next couple of weeks.
Michael Gable is managing director of Fairmont Equities.
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