EUR 850.00 For Business Accounts Only

Morningstar | Genworth’s Strong Regulatory Capital Position Supports Capital Initiatives

No-moat-rated Genworth’s fair value estimate of AUD 2.80 is unchanged following in-line first-half 2018 results. We still forecast underlying net profit after tax of AUD 100 million for 2018 after the company reported underlying NPAT for the half of AUD 50.3 million and statutory NPAT of AUD 41.9 million. We also continue to forecast ordinary and special dividends totalling AUD 24.5 cents per share in 2018, with the company declaring an ordinary interim 2018 dividend of AUD 8 cents and a special dividend of AUD 4 cents. The firm’s strong regulatory capital position allows it to maintain a high dividend payout ratio and continue with the on-market share-buyback program that commenced in May. The buyback program has already acquired about AUD 35.3 million worth of shares. Since listing on the ASX in 2014, the company has paid out all aftertax profits by way of ordinary and special dividends, as well as instituting several share-buyback programs. At current prices, the stock is fairly valued.

We believe the firm’s strong balance sheet and lack of major investment opportunities will provide scope for further capital initiatives. Its prescribed capital amount, or PCA, ratio of 1.9 times as at June 30, 2018, is relatively unchanged from Dec. 31, 2017, and significantly higher than the company’s target range of 1.32-1.44 times. Even with the current capital initiatives, the pro forma PCA ratio will still be above Genworth’s target range at about 1.8 times. The company continues to implement strategic initiatives aimed at diversifying its revenue stream from its core lenders mortgage insurance, or LMI, product by investing in new complementary businesses, including its new Bermudan insurance entity, micromarkets LMI, and excess cover. From the limited information disclosed about these investments, they appear unlikely to materially affect Genworth’s PCA and reserving, leaving scope for further returns to shareholders.

We expect lower housing credit growth in Australia, with the major banks increasing their focus on strengthening lending standards, to continue affecting Genworth’s core LMI business. Australia’s historically high housing debt and regulatory focus on responsible lending following the 2018 Royal Commission will negatively affect the volume of housing loans originated with a high loan/value ratio. High-LVR housing loans as a percentage of new residential loans has progressively fallen from 37% in 2008 to 21% in 2017, and Genworth forecasts stabilisation around 20% in 2018. In 2018, these macroeconomic headwinds have been exacerbated by the company’s earnings curve review, which took effect from Oct. 1, 2017. This review lengthened the time over which premiums are earned, although it does not affect the quantum of revenue that will be earned over time. It results in lower net earned premium, or NEP, recognised in earlier years, with most of the negative impact occurring in 2018 and the impact gradually decreasing into 2019. The lower NEP also results in a higher loss ratio, which was 53.3% in first-half 2018, up from 34.8% a year ago, and expense ratio, which was 32.9% in first-half 2018 versus 25.9% in first-half 2017, with both ratios using NEP as the denominator.

In the face of these headwinds, one saving grace for the company is its strong balance sheet and regulatory capital position. The key driver of the company’s strong regulatory capital position is the continued reduction in its probable maximum loss risk charge. The lower PML charge results from progressively insuring mortgages with a lower LVR, as well as the continual decline in the large book of higher-risk loans written in 2006 to 2008, and the reserving and payments already made relating to the mining industry slowdown. As noted, its strong capital position and lack of material investment opportunities provide future scope for capital initiatives.

The company’s guidance for 2018 is unchanged. While it is monitoring the softening cure rates that began in first-quarter 2018 and continued in the second quarter, this was offset by signs of improvements in mining areas. The lower cure rates were concentrated in nonmining areas, with delinquencies in mining areas showing signs of slowing improvement. However, overall, there was a 3-basis-point increase in delinquencies, primarily driven by increased delinquencies in New South Wales and the nonmining areas of Western Australia. The higher delinquency rate was mainly due to a reduction in policies in force resulting from its new Lapsed Policy Initiative. This initiative uses data analytics to more promptly identify loans that have been refinanced or discharged. It resulted in a step-change reduction of 50,000 policies in force, but we expect future changes to be more incremental. It also led to the release of AUD 8.2 million in unearned premiums. The delinquency rate is calculated as the number of delinquencies divided by policies in force excluding excess of loss insurance.