Few companies are more exposed to a Canadian housing correction – or lack thereof – than Genworth MI Canada Inc.
When fears of bursting bubbles consumed markets mid-2012, investors punished the mortgage insurer. But as the real estate market demonstrated its resiliency, the huge discount imposed on Genworth’s stock has vanished.
It’s been a torrid streak for those who took a stake in the depressed equity. Now at an all-time high, the stock appears set to level off.
“The easy money has been made,” said Irwin Michael, portfolio manager at ABC Funds. “It was dirt cheap. It’s fairly valued right now. But are we selling our stock? No. It’s still a solid company.”
Genworth’s third-quarter earnings announcement, scheduled for Tuesday, is expected to reflect a housing market that refuses to slow down.
“Housing demand has picked up steam since the beginning of the year and resale volumes are now back to long-run averages,” CIBC World Markets analyst Paul Holden said in a note. “Housing prices continue to be firm without any pockets of material pricing pressure.”
This strength comes despite the federal government’s clampdown on the mortgage market and despite the popular opinion that residential real estate was due for at least a soft landing, if not something harsher.
As a competitor to the Canada Mortgage and Housing Corp., Genworth insures the mortgages of those homeowners who put down less than 20 per cent of a home’s value. A housing crash could expose the company to a spike in loan losses, a risk made explicit by the U.S. housing collapse, which embroiled the company’s majority shareholder, Genworth Financial Inc. The U.S. parent company struggled to keep up with a flood of defaults on risky mortgages it had insured, while its stock plummeted from more than $30 (U.S.) to less than $1 in one year. The need for immediate capital led the U.S. insurer to list its Canadian subsidiary in 2009.
Although the Canadian federal government guarantees 90 per cent of Genworth’s mortgage insurance obligations, the company is on the hook for defaults as long as it remains solvent. The company said it can handle that exposure and that it has passed stress tests by virtue of its excess capital of about $370-million (Canadian). As of the end of the second quarter, the company’s minimum capital test ratio – a measure of capital available to capital required under various risk scenarios – stood at 216 per cent, well above its internal target of 185 per cent. Still, Genworth’s fortunes remain inextricably linked to housing performance.
Worries that Canadian homes were critically overpriced bore heavily on Genworth, which sunk to a low of $16.84 in July, 2012. At its depths, the stock traded at a bargain basement price-to-earnings multiple of 5.3 times. Its valuation dropped to just 60 per cent of the company’s book value.
Relief at the housing crisis averted, or at least deferred, lifted the stigma from Genworth. Its share price increased by almost 90 per cent over the past 15 months, and is now close to $32, which Mr. Michael pegs as the estimated year-end book value.
Investors have also been rewarded with both an ongoing share buyback program and annual dividend increases, a tradition the company is expected to uphold when it discloses its quarterly earnings. Even after the recent rally, the stock is still yielding 4 per cent.
While high-risk mortgage volume has been declining as a result of the changes to federal mortgage regulations, the outlook for the quarter also improved as a result of the recent spike in home sales, Mr. Holden said. Each month of the quarter posted substantial year-over-year sales increases. “At the beginning of the year we were expecting resale volumes to be down around 10 to 15 per cent,” he said.
Some of that activity is thought to be in response to rising mortgage rates, as homeowners seek to lock in to cheaper mortgages. But now that the Bank of Canada has deferred a policy rate hike, mortgages should remain attractive for the time being. And lower rates will help keep mortgage delinquency low and keep claims on Genworth-insured mortgages in check.
“Actual claims experience will be driven by unemployment rates, housing prices and the credit quality of underlying insured mortgages,” Mr. Holden said. On all fronts, there are few signs of trouble.
But while the stock has its selling points, there is little hope for anything close to the magnitude of capital gains posted over the past year or so. “It’s not a growth play,” Mr. Michael said. “But it provides ballast to a portfolio that wants a little bit of income and some appreciation.”