Don’t be put off by the 242-page Product Disclosure Statement – the Genworth Mortgage Insurance Australia Limited IPO is priced to sell. Yield investors, who scroll through this document using the 11-page glossary of acronyms, will discover a mono-line insurance business that will in most years, provide an attractive income return. They will also discover a business that is incredibly capital intensive.
Genworth Mortgage Insurance
Genworth is the leading provider of lenders mortgage insurance (LMI) in Australia with approximately 45% market share and an insurance book of $300 billion of mortgages. LMI facilitates residential mortgage lending by transferring risk from lenders (banks) to LMI providers such as Genworth, predominantly for high loan to value ratio (HLVR) residential mortgages. HLVR mortgages are typically those with an LVR over 80%, with 75% being owner occupied loans and 25% being investor loans.
One in every three residential mortgages in Australia attracts LMI. While the premium is effectively paid by the borrower, the insurance is arranged by the lender as a condition of the loan. Accordingly, 86% of Genworth’s new business is sourced from banks who operate under a “Supply and Service Contract”, with 66% coming from Commonwealth, NAB and Westpac.
The Genworth LMI business has been operating in Australia for almost 50 years. Originally set up by the Australian Government as the Housing Loans Insurance Corporation, a subsidiary of General Electric purchased the business in 1997 and this was later reorganised under the ownership of Genworth Financial. Genworth says the business has been profitable for 46 out of the last 48 years.
Genworth Financial (a US based “Fortune 500” company) is selling between 30% and 40% of its equity to “reduce risk and rebalance capital amongst its three major mortgage insurance platforms, being the US, Canada and Australia”. All of the funds being raised, between $429m and $754m, will be repatriated to Genworth Financial.
An indicative price range of $2.20 to $2.90 per share has been provided, with the final price to be set via an institutional book build. This values the Genworth business at between $1.43 billion and $1.89 billion. Retail investors won’t pay any higher than $2.90 per share.
Details of the IPO are as follows:
Attractive dividend yield, appalling ROE
Genworth is forecasting an underlying NPAT of $231.1 million in calendar year 2014, compared to $220.9 million in CY 2013, $119.1 million in CY 2012 and $199.0 million in CY 2011. With a dividend payout ratio target of 50% to 70% of underlying NPAT, the directors have assumed 55%, which translates to a forecast dividend yield of 8.9% per annum at the bottom of the price range, or 6.7% per annum if the price is $2.90. Further, the dividend should be fully franked.
While this and other metrics, such as the price/book and price/earnings ratios make this company look very attractive, this is a capital-intensive business and the return on equity is appalling at only 10.2% (10.4% in CY 2013, 5.8% in CY 2012, 10.3% in CY 2011). Genworth says its target is to increase ROE on new business to the low to mid teens, and it will consider “further capital management initiatives”.
Apart from the risks that come from an APRA regulated mono-line insurance business servicing the residential mortgage industry (such as the normal housing cycle risks), there are three other risks that are worth calling out. Firstly, Genworth Financial is only selling part of its share-holding and there must be a risk that it sells further shares. While it has entered into a ‘voluntary escrow’ for its remaining shares and has “no current plans to further reduce its holding following the expiry of the disposal restrictions in the voluntary escrow deed”, this escrow expires after the lodgement date of its 2014 accounts, sometime in February 2015.
Secondly, with three banks accounting for 66% of its new business, this creates a major customer exposure risk when these contracts come around for negotiation, commencing in 2015. Genworth also notes that lenders may retain a greater level of risk on their own books, meaning less business for Genworth and/or potentially riskier business.
And finally, Genworth notes that post 2009, it has been writing new business at better margins due to a change in pricing policy. In fact, the average premium rate has more than doubled over the last 10 years – raising questions about the ability of Genworth to extract higher margins going forward.
While not an annuity style investment (due to the cyclical nature of the housing market and the variability of insurance underwriting profits), this investment will suit some yield-hungry investors who are prepared to take on a little more risk. Invest in moderation – not as a core stock, and it is unlikely to see much price upside post the listing.
There is no general public offer, however shares will be available to retail investors on a “firm offer” basis through the participating brokers, which include CommSec, Deutche, JB Were, JP Morgan, Macquarie and UBS.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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