by
Justin McCarthy | Aug 13, 2013
Genworth Financial Mortgage Insurance Pty Ltd (Genworth Australia), has reported its 2Q13 results (to 30 June 2013) as part of the parent’s (Genworth Inc.) results release in the USA. While profitability has stabilised we are increasingly concerned by lower levels of capital and a persistent trend of declining minimum capital ratio (MCR), this time due to a large dividend payment from the Australian operation back to the US parent.
Key points from the 2Q13 results were as follows:
- Second quarter operating profit was US$55m which was up from US$46m in the prior quarter and US$47m a year ago
- Premium income has been effectively flat over the past 12 months and investment income has decreased
- The driver of the improved performance was continued improvement in claims expense. This was just $36m (35% loss ratio) down from $48m (47% loss ratio) last quarter and from $138m in the first quarter of 2012 when claims peaked
- The delinquency ratio also improved to 0.40% which is down from 0.41% in the prior quarter and 0.52% at 30 June 2012
- Queensland remains the worst state for delinquencies with a ratio of 0.54% with pre-GFC loans (2007 – 0.82% and 2008 – 0.98%) the worst years for problem loans
- The regulatory or minimum capital ratio (MCR) at 30 June 2013 was 134% which, while above minimum requirements, is at the very low end of where we would like to see the ratio. In early 2012 this ratio was as high as 161% and has steadily declined over the last six months from 4Q12 149% to 1Q13 144% and now down to 134%. This latest reduction is due to a large dividend paid from Genworth Australia to the parent in 2Q13. As previously written, the consistent reduction in capital is a concern
- IPO of the Australian operation is still slated for 4Q13/1H14
Conclusion
Overall, it was a solid second quarter result from Genworth on an operational front. Profitability continues to improve (despite the lack of revenue growth) on the back of an improving domestic mortgage market.
However, the MCR remains a concern and as highlighted in previous articles if this was not improved we were likely to downgrade our credit assessment. It is the MCR that is the buffer between a residential property market price crash and/or spike in unemployment and repayment of their subordinated bond. It is only when times are tough you need the capital and the declining trend and recent announcement of a company target for 135% MCR that is of concern to us from a longer term viewpoint.
To a lesser extent, the persistent delays in the IPO have also raised concerns. If Genworth can undertake an IPO of its Australian business this would be considered a significant credit positive, both by opening up access to potential equity capital raisings and by improving the standard and detail in reporting. Given previous delays we will wait for this to occur before reflecting it in our credit assessment. As detailed above, management have stated this will occur in 4Q13 or 1H14.
Notwithstanding the above, as we have always written, an investment in Genworth Australia is ultimately an investment in the outlook for property prices, unemployment and mortgage affordability/interest rates in Australia. We remain of the view that a property crash is unlikely with increases in house prices gathering pace. We note a recent report from Standard & Poor’s placed a 5% chance of a property crash, with house price declines of 25%. However, the picture for unemployment does appear to be deteriorating, albeit from very low levels. Finally, with very low interest rates, and expectations that such low rates will persist, mortgage affordability remains supportive.
Genworth Australia subordinated bonds are trading at an indicative bid/offer credit margin +290/250bps. From a relative value point of view we prefer investments in junior tranches of residential mortgage backed securities (RMBS) that are mortgage insured by Genworth Australia (or QBE). While they can be difficult to source, these mortgage insured junior RMBS tranches not only offer superior returns (circa +300bps), they are also viewed as stronger credits with repayment sourced firstly from the underlying mortgages and if that fails there is a “call” on the mortgage insurer. Moreover, that “call” on the mortgage insurer is a senior obligation, as opposed to the subordinated level of the existing Genworth Australia bonds, subject to the insurers’ willingness to pay.
(Please refer to Focus on Mortgage Markets Part III article for more on this topic).
All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities. Genworth Australia subordinated debt and RMBS are only available to wholesale investors.