The big four banks have attracted a lot of attention as debates continue across the nation regarding property affordability and whether the exuberant property market is heading for a cliff. The public outcry against property prices has lead to banks reigning in their lending standards in order to comply with APRA's stance on investor loan growth. These measures have partly contributed to the share price pull back seen over the past month.
The banks' partner in crime in writing risky investor loans are mortgage insurers such as Genworth Mortgage Insurance Australia Ltd (ASX: GMA). Property investors usually opt for high LVR loans (>80%) to maximise tax deductibility of interest payments and minimise initial outlay. However the share price for Genworth has hardly budged over the past three months – is now the time to sell?
The case for
Although APRA's stance on investor loan growth signals a curtailment in demand for Lenders Mortgage Insurance (LMI), it is important to remember that risk taking goes in cycles.
The main concern in my opinion is the viability of LMI business in Australia. Like all insurance business models LMI is based on the pooling of risk to allow a more accurate assessment of potential claims, which requires the business to operate at a large scale.
The decision of Westpac to pull its business from Genworth in February creates uncertainty around its other big four bank clients. Whilst NAB has recently renewed its contract the major risk is CBA, who accounted for over 40% of gross written premiums in FY13. CBA's contract expires in 18 months and losing this contract could be catastrophic.
The case against
With the stock yielding a juicy 4.89% and a Price-to-Book (P/B) ratio of 0.84 it could be argued that the stock is worth investing in. However the low P/B ratio probably factors in the chance of Genworth losing other clients in the future. Whilst the viability of the business model has been questioned, some commentators have flagged the attractiveness of Genworth as an asset play.
Under the asset play scenario the company will cease to write new business, and simply allow its existing policies to run off. On UBS's numbers, Genworth could deliver total capital returns from this financial year to 2019 of $4 a share in run off, above book value of $3.85.
Buy, Sell or Hold?
As an investor looking to buy in I would advise that you hold off until there is more clarity around CBA's intentions to renew its contract.
As an investor that's already holding the stock I think there's value in continuing to hold as an asset play. The majority of policies in force for the company were written post 2008, a period where they stopped writing policies for LVRs above 95% and began differential pricing of its policies. Based on the statistics from its prospectus there has been a significant reduction in claims and a better ratio of claims to gross written premium on these policies, suggesting that there could be significant value in the stock as an asset play.
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