Last week, real estate and mortgage industry members were abuzz when Canada Mortgage and Housing Corporation (CMHC) announced it would be making an announcement. Speculation was rampant guessing what CMHC — which insures mortgages against default for the benefit of the lender — would announce. Would it increase the minimum down payment needed, from 5% of the property’s value to 10%? Or would it take the axe to other programs, like ones designed to make it easier for immigrants to buy homes?
On Friday morning, CMHC announced that effective May 1, mortgage default premiums would increase by an average of 15%. Insurance to buy a property with 5% down jumped from 2.75% to 3.15%, causing an increase in the monthly payment of about $5 per month, assuming a $250,000 mortgage and a 3.5% interest rate.
In other words, this isn’t such a big deal for consumers. There is one stock that will feel the effects of this, and it’s Genworth MI (TSX:MIC), Canada’s largest privately owned mortgage insurer.
Genworth has a market share of approximately 25-30%, while CMHC owns the rest. While it has the freedom to set its insurance prices differently than CMHC’s, Genworth currently matches every program and every price CMHC has, including this new increase.
Genworth’s advantage is that it tends to use common sense underwriting when approached with unorthodox borrowers — like self-employed folks — while CMHC is more by the book. Alternative lenders like Home Capital (TSX:HCG) use Genworth significantly more than CMHC because of this.
The company also has government protection in the event of a catastrophic housing meltdown. If it’s ever forced to pay out so many claims that it becomes insolvent, the Canadian government will step in and pay 90% of what it owes. While this isn’t the 100% protection CMHC enjoys, it’s still a reasonable amount to convince lenders to do business with the company.
Like any other insurance company, Genworth invests the premiums it collects, making money on these investments. Even though the float is only averaging a 3.8% yield thanks to low interest rates, the company continues to be very profitable due to low loss payouts and its lean structure. Net profit margins are consistently better than 50%.
Genworth has a current book value of $32 per share, just a little more than 10% less than the $36 share price. It trades at less than 10 times trailing earnings, and the upcoming 15% hike in revenue should fall mostly to the bottom line. Genworth earned $3.85 per share in 2013 and could easily see earnings increase to over $4.00 in 2014. Capital ratios are currently sitting comfortably above self-imposed limits as well.
The dividend has been growing steadily since the company was spun off from its parent General Electric in 2009, growing from 22 cents per quarter to 35 cents, which is a current yield of 3.9%. Genworth has also been aggressive buying back shares during that time, reducing the number outstanding from 114 million to 97 million, with additional purchases planned in 2014.
Ultimately though, Genworth is driven by sales activity in the Canadian housing market. New premiums written did decline in 2013 compared to 2012, but 2012 was an exceptionally strong year. The much hyped decline in housing hasn’t hit Canada yet, but if it does, the slowdown in both new premiums and the increase in claims will hurt the company substantially. This is the main reason Genworth trades at such a reasonable valuation.
Foolish bottom line
Genworth is firmly entrenched in its market, enjoys essentially fixed pricing, and is getting a huge increase in revenues for the first time in more than a decade. It also has government protection if things go really bad, and is trading at cheap price-to-book and price-to-earnings ratios. If you’re a believer that the housing market will continue to creep higher, then Genworth belongs in your portfolio.
