Genworth MI Canada's (GMICF) CEO Stuart Levings on Q3 2016 Results - Earnings Call Transcript

| About: Genworth MI (GMICF)

Genworth MI Canada Inc. (OTC:GMICF) Q3 2016 Earnings Conference Call November 4, 2016 10:00 AM ET

Executives

Jonathan Pinto - Vice President, Investor Relations

Stuart Levings - President and Chief Executive Officer

Philip Mayers - Chief Financial Officer

Analysts

Geoff Quan - RBC Capital Markets

Paul Holden - CIBC

Tom MacKinnon - BMO Capital Markets

Graham Ryding - TD Securities

Operator

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Genworth MI Canada Inc. 2016 Third Quarter Earnings Conference Call. [Operator Instructions] I would like to remind everyone that this conference call is being recorded today. I will now turn the conference call over to Mr. Jonathan Pinto, Vice President, Investor Relations. Mr. Pinto, you may proceed.

Jonathan Pinto

Thank you. Good morning, everyone and thank you for joining Genworth Canada’s third quarter 2016 earnings call. Leading today’s call are Stuart Levings, our President and Chief Executive Officer and Philip Mayers, our Chief Financial Officer. We will start with our prepared remarks, followed by an open question-and-answer session.

Our news release, including our management’s discussion and analysis, the financial statements and financial supplement were released last night and are posted on our website at www.genworth.ca. A link to our live webcast and the slides for today’s discussion are also posted on our website. A replay of this call will be available via the other number noted in the press release and will also be available on our website following today’s presentation. The call will be available online for approximately 45 days following today.

As a reminder, our presentation and discussion today contain a disclaimer on forward-looking statements and non-IFRS statements on disclosure. We note that our actual results may differ from statements that we make, which are forward-looking. We advise you to read the cautionary note regarding these forward-looking statements. As well, some of the financial metrics presented on this call today are non-IFRS measures, and as such, do not have a standardized meaning and are unlikely to be comparable to similar measures by other companies.

I would now like to turn the call over to Stuart, to begin his remarks. Stuart?

Stuart Levings

Thanks, Jon. Good morning and thank you for joining our third quarter earnings call. We are pleased with our strong business performance this quarter, particularly our loss ratio, which continues to develop in line with our expectations, as well as the strong momentum in premiums earned driven by premium rate increases and larger recent books of business. For the quarter, we delivered net operating income of $93 million, up 1% over the prior year period. This generated an operating return on equity of 11% and diluted operating earnings per share of $1.02, up 2% over the prior year period. Premiums written totaled $223 million, down $37 million or 14% over the prior year period. This was primarily due to targeted underwriting changes in select markets and a smaller transactional insurance market size, partially offset by a higher average premium rate from the June 2015 increase.

First-time homebuyers have been feeling increasing levels of affordability pressure over the past 12 to 18 months, particularly in the Greater Toronto and Vancouver markets, forcing them to buy further out in the suburbs or target more affordable property types such as condos. I will cover the recent changes to mortgage insurance eligibility rules later in my prepared remarks. However, we believe these changes will put additional pressure on affordability in the short-term.

As highlighted during our second quarter earnings call, we saw a decline in the demand for portfolio insurance post-implementation of the purpose test rules, effective July 1 of this year. New insurance written from portfolio insurance was $6.5 billion, down $19.4 billion from the prior quarter and up $400 million over the prior year period. These transactions continue to reflect very high-quality portfolios with low and low-inter value mixes and higher average credit scores, as evidenced by the lower average premium rate compared to the prior year.

As previously noted, we are pleased with our loss ratio, which came in at 25%, up 4 points over the prior quarter. This result is in line with our expectations, driven largely by a build in the number of net new delinquencies from oil-producing regions. We ended the third quarter with an MCT ratio of 236%, up 3 points over the prior quarter. While this level is moderately higher than our targeted range of 225% to 230%, we have been managing capital to a higher level in light of a new test under development by OSFI. As noted in our press release dated September 23, 2016, OSFI released their draft advisory requesting industry comments on the new capital framework. The proposed framework, much of which we support, represents a fairly material departure from the current model.

Phil will cover this topic in greater detail during his prepared remarks. However, I will note that subject to business and market conditions, we expect to be fully compliant with the new framework upon its implementation on January 1, 2017. Overall, our capital priorities remain focused on supporting our core business volumes and ordinary dividend. On that note, we are very pleased to announce a 5% increase in our ordinary dividend to $0.44 per common share, up $0.02 over the last quarterly dividend. This change represents the seventh consecutive increase in our ordinary dividend since becoming a public company in 2009. Our book value, at $39.01 per share, continues to grow, up 8% over the prior year period driven by ongoing [indiscernible].

Turning to the economy, it’s clear that the macroeconomic and housing themes discussed on our second quarter earnings call continued to evolve. Economic growth remains constrained as evidenced by the Bank of Canada’s recently lowered expectations for 2017. Oil prices remain pressured and appear to be range-bound between $40 and $50 per barrel, while housing markets continued to diverge. That said, the focus is now largely on the Greater Toronto market versus the rest of the country, given the early signs of a slowdown in the Vancouver market. This slowing trend may be somewhat exacerbated by the recently announced mortgage rule changes. Outside of the Greater Toronto and Vancouver area, housing markets are generally stable.

As you know, on October 3, 2016, the Minister of Finance announced a number of mortgage insurance rule changes, including the requirement to use the posted 5-year mortgage rate published by the Bank of Canada to determine borrower debt service ratios on all insured loans after October 17 this year. Based on our initial assessment, we concluded that approximately one-third of the borrowers we have insured year-to-date would no longer qualify under the maximum debt service ratios, as noted in our press release dated October 4, 2016. In that release, we also suggested that a portion of those borrowers impacted would likely still purchase a house by altering their price level or increasing the amount of their down payment.

Upon further analysis, we determined that approximately 30% of those borrowers impacted are within 2 points beyond the maximum debt service ratio, either gross debt, total debt or both, and could potentially find a lower price home. In addition, a little over half of the total impacted borrowers are constrained by their total debt service ratio alone. In our view, a number of those borrowers may be able to restructure or consolidate their other debts to improve their total debt service ratio. As a result, we believe the transactional insurance market may decline by approximately 15% to 25% in 2017.

The minister also noted certain changes to the low loan-to-value mortgage insurance rules, including the elimination of a number of mortgage products such as newly originated refinances and single unit investment loans. In our October 4 press release, we indicated that these changes would reduce the volume of our portfolio insurance by approximately 50% to 55%. However, based on further clarifications provided by the Department of Finance regarding the grandfathering of mortgages originated prior to November 30, we revised our estimate and now anticipate a 25% to 35% reduction compared to the normalized run rate after the July 1, 2016, regulatory changes or purpose test rules. Clearly the changes will impact the size of our transactional and portfolio insurance markets. However, as is seen with previous mortgage rule changes, borrowers gradually adapt and the markets tend to recover. As noted, borrowers may alter their behavior, purchasing lower-priced homes, making larger down payments or restructuring other debts to address total debt service ratio constraints.

In addition, these changes may drive some price softening as housing activity slows, gradually helping to ease some of the affordability pressure evident today. Furthermore, the changes made to the low loan-to-value market may create an opportunity for a private non-government guaranteed entity, as the loans eliminated by the changes are generally good prime loans, a risk profile we are comfortable with. To that end, we are currently exploring such an entity as it would enable us to recapture a portion of the portfolio insurance market.

Finally, I would also like to point out that the impact on premiums written from the smaller market size should be partially offset by any future premium rate increases in response to the higher capital requirements as previously discussed. Overall, our transactional portfolio quality remains extremely high, with an average credit score of 752 year to date. While the government changes create a smaller market, the portfolio quality is likely to improve as the number of marginal borrowers, are excluded from the mix. Our typical first-time homebuyer continues to be fiscally prudent, limited by income growth and qualifying criteria, which is largely why the median house price in our portfolio remains well below the market average.

Generally speaking, portfolio quality today is significantly improved over the ‘07/08 time period and should produce less performance volatility in a similar economy downturn. On October 21, 2016, the Minister of Finance launched a consultation document to help determine the relative narrative of modifying the distribution of risk in the housing finance system by requiring mortgage lenders to manage a modest portion of the loan losses on an insured mortgage’s default. The commentary for this consultation ends on February 28, 2017.

While it’s too early to comment on the potential impact of this process and its ultimate outcome, we have always been of the view that today’s mortgage lenders are well aligned with mortgage insurers in terms of risk management, underwriting quality and document due diligence. We continue to see a higher standard of underwriting from our lenders and our portfolio performance supports this view. That said, we will participate in this consultation and are currently evaluating the various questions and proposals put forth by the government in the paper. We ended the quarter with a total of 2,027 delinquencies outstanding, representing an increase of 312 delinquencies over the same quarter in the prior year and an increase of 66 over the prior period.

The year-over-year change was driven primarily by an increase of 360 delinquencies outstanding in Alberta, partially offset by decreases in Ontario, Québec and British Columbia. New delinquencies net occurs increased by 141 over the prior quarter, largely due to Alberta and to a lesser extent, Québec. While the Québec region saw an increase quarter-over-quarter, the number was down from the same period in the prior year. We continue to view the Québec market as generally improving and expect to see this reflected in the region over the next few quarters. We have been monitoring oil-exposed regions very closely over the past 18 months. And although oil prices have seen some stability since the beginning of the year, we recognize that these areas have sustained significant job losses. Since the end of 2014, the Alberta unemployment rate has increased 400 basis points to its current level of 8.5%. While it took longer than we anticipated, we are seeing a build in new delinquencies from these regions. Third quarter new delinquencies net occurs in Alberta are up by 159 over the prior year period and 109 over the prior quarter. We expect this trend to continue during the fourth quarter of this year and into 2017.

We also expect house prices in Alberta to soften further, but still within our estimated range of approximately 5% to 10%. That said, we remain optimistic that the outcome in Alberta will be less severe than what we saw in the ‘07 and ‘08 downturn, largely due to three important differences in the current cycle: a significantly more conservative product suite; improvements in underwriting and fraud detection; and less housing over-evaluation risk. As a reminder, just over 30% of our peak losses in the ‘07, ‘08 downturn were driven by products that the government eliminated in the years following the global financial crisis. In addition, housing values dropped materially during that cycle, as much as 20% for some property types in Calgary and Edmonton.

Improvements in underwriting include advances in property valuation routines, better fraud detection technology and enhancements to our proprietary loan scoring model. The improvements are evident in our overall credit scores, our stable debt service ratios and a very low level of early term delinquencies. While we haven’t taken any additional underwriting actions these past two quarters, we are comfortable with the quality of loans we have insured. The cumulative effect of past actions, together with a slower more cautious housing market, has reduced our overall distribution of new business written in Alberta to approximately 17% year-to-date. We expect our new insurance written will stabilize around that level, with potential for modest growth over the next 12 to 18 months. While we are maintaining our estimated loss ratio range of 25% to 35% for 2016 based on year-to-date results, we expect to end the year with a full year loss ratio in the lower half of this range. We will provide some early thoughts on our estimated range for the 2017 loss ratio at our annual Investor Day on December 7, 2016.

On an unrelated note, our major shareholder, Genworth Financial, recently announced that they have entered into a definitive agreement under which they will be acquired by China Oceanwide Holdings Group Company Limited, a family-owned international financial holding company. According to their October 23, 2016 press release on this matter, Genworth Financial intends to maintain its existing portfolio of businesses, including its mortgage insurance businesses in Canada and Australia. The transaction is subject to approval by Genworth Financial stockholders and applicable regulators, including approval by the Minister of Finance under the Insurance Companies Act of Canada. We do not anticipate any change in our business strategy or day-to-day operations as a result of this announcement. Our management team and Board of Directors remain unchanged and we are proud to serve our mortgage lenders as Canada’s largest private residential mortgage insurance provider.

With that, I will turn it over to Phil for a deeper look at our financial results.

Philip Mayers

Thanks, Stuart and good morning. Our financial results continue to be solid in a mixed economic climate. Overall, net operating income declined to $93 million, primarily due to the 4 point sequential increase in our loss ratio to 25%. This was partially offset by higher premiums earned. Total premiums written were $223 million, down modestly sequentially. Premiums written from transactional insurance were $201 million, representing an increase of $30 million over the prior quarter due to a seasonally larger mortgage origination market and a modestly higher average premium rate. As expected, we saw a significant decrease in premiums written from portfolio insurance after the implementation of the July 1, 2016 regulatory change, which restricts the use of portfolio insurance by lenders.

We achieved premiums written of $22 million with $6.5 billion of portfolio insurance. This compares to the $26 billion insured in the second quarter prior to the regulatory change. Premiums earnings grew by 10% year-over-year to $162 million. This growth reflects the higher level of premiums written in recent years as evidenced by a 9% year-over-year increase in the unearned premiums reserve to $2.1 billion. The continued pressure in the oil-producing regions was the principal driver behind our losses on claims of $41 million.

New delinquencies net of cures increased by 141 sequentially, including an increase of 109 in Alberta, as Stuart noted. This was coupled with a modest 5% sequential increase in the average reserve for delinquency, reflective of the higher mix of Alberta delinquencies. Looking forward to this coming quarters, we expect the elevated level of losses in Alberta to persist due to the ongoing macroeconomic pressures. Our expense ratio was 20% or $33 million of total expenses and is consistent with the company’s expected operating range of 18% to 20%. Overall, underwriting income was $88 million, a sequential decrease of $7 million as the increased losses on claims and expenses, outweighs the higher level of premiums earned.

Our $6.2 billion investment portfolio contributed $44 million of interest and dividend income. This was flat sequentially as modestly higher invested assets offset the ongoing rate pressure. In total, net operating income of $93 million generated an operating return on equity of 11% and a fully diluted operating EPS of $1.02. Our diluted book value per share grew by 8% year-over-year and now stands at $39 inclusive of AOCI. Our underwriting profits have been relatively consistent over the past five quarters, ranging between $88 million and $95 million. Generally, these results reflect a trend of increasing premiums earned, which has largely offset higher losses in claims.

Our loss ratio for the first nine months in 2016 was 23% and we expect that the full year loss ratio will be in the lower half of our 25% to 35% range for 2016. This reflects the typical seasonal uptick in losses on claims in the fourth quarter. In addition, we expect premiums earned in the coming quarters to be flat or modestly higher driven by the stabilizing impact of our large unearned premiums reserve. Overall, we expect our solid underwriting profits to continue in the coming quarters.

Turning to investments, we manage our $6.2 billion portfolio with a focus on high-quality fixed income investments and maintaining or improving the portfolio yield over time. In 2016, we have offset the rate pressure by modestly increasing our allocation to investment grade preferred shares with attractive dividend yields. Sequentially, this has resulted in a relatively consistent portfolio yield of 3.2% in a portfolio duration of 3.8 years. Going forward, we will continue to actively manage the portfolio, but do not anticipate any material shift in asset allocation.

With respect to capital management, our Minimum Capital Test or MCT ratio was approximately 236%. We held $181 million of holding company cash and liquid investments. As well, as Stuart noted, we announced a $0.02 increase in our quarterly dividend to $0.44 per quarter. This puts us close to the top end of our targeted 35% to 45% dividend payout range. We feel comfortable with this level of ordinary dividends in light of our ongoing profitability, expected capital usage going forward and existing capital flexibility. We continue to operate with a strong MCT ratio to smoothly manage transition to the near capital framework outlined in OSFI’s drafted advisory on capital requirements for mortgage insurers released in September. The proposed framework is more risk-sensitive and uses credit score, loan-to-value, remaining amortization and outstanding loan balance to determine the total asset requirement for insurance risk.

The comment period with respect to the draft advisory ended on October 21 and the finalized advisory is expected to come into force on January 1, 2017. Under the new capital framework, the total asset required for insurance risk consists of a base requirement and a supplemental requirement. In turn, capital required for insurance risk will equal the total assets required plus premium liabilities consisting of unearned premium reserve and the reserve for incurred, but not reported claims. We favor this approach given that it provides the appropriate pricing incentives. For example, an increase in the premium rate lowers the capital requirement given that the total assets available to satisfy its all similar obligations, remains the same.

The base requirement applies to all insured mortgages, while the supplementary requirement only applies prospectively to mortgages insured after January 1, 2017 and cities where the regional house price to income ratio exceeds the OSFI-specified threshold. The metropolitan areas of Vancouver, Calgary, Edmonton and Toronto currently exceed their respective proposed threshold values by a significant margin and will likely attract supplementary capital throughout 2017. These cities represent approximately 35% of our transactional new insurance written. The new framework recalibrates the capital required at the current holding target of 220% to the OSFI supervisory MCT target of 150%. As a result, there is a meaningful difference between the entity ratio under the new and old frameworks.

For Genworth Canada, 1 MCT point under the current framework represents approximately $15 million, whereas under the new framework, 1 MCT point represents approximately $25 million. Based on draft advisory, we estimate that our pro forma MCT ratio was between 155% and 158% at September 30. Before the transition to the new framework, the draft advisory provides a faith incurred for the capital requirements in three areas: legacy portfolio insured mortgages; legacy transactionally insured mortgages with extended amortizations; and operational risk. The details for the transitional provisions are outlined in our management discussion and analysis.

As Stuart noted, we expect to be compliant with the new framework components implementation on January 1, 2017, subject to business and market conditions. Under the new framework, the base total asset requirement for insurance risk is substantially higher for loan-to-value less than or equal to 90%, as compared to the equivalent total asset requirement under the current MCT. The resulting higher level of required capital for both the base and supplementary requirements will likely result in premium rate increases in order to maintain appropriate returns in invested capital. In summary, despite several regulatory changes in 2016, our business model remains sound with strong capitalization and a solid return profile.

I will now turn the call back to Stuart to conclude our prepared remarks.

Stuart Levings

Thanks, Phil. As we near the end of 2016, we remain focused on the following key areas: active expense management; prudent underwriting targeting prime quality, first-time homebuyers purchasing homes below the market average and comfortably within our debt servicing guidelines; and proactive industry leading loss mitigation efforts to reduce claims cost and avoid unnecessary foreclosures. We believe our prudent business model with its high-quality insurance portfolio, stable revenue stream and conservative investment portfolio is well-positioned to withstand economic pressures. We remain confident that this model, together with the tailwinds from our strong level of unearned premiums, should position us well over the coming quarters. Thanks for listening. That concludes our prepared remarks.

We are ready to commence with Q&A and I will now turn the call back to the operator.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question will come from the line of Geoff Quan of RBC Capital Markets. Please go ahead.

Geoff Quan

Hi, good morning. Just had a couple of questions. The first one is just in relation to the changes announced by the Department of Finance and just was wondering if you saw any spike in applications prior to the deadline. And if so, was it very material? And then, secondly just maybe any sort of general trends that you are seeing since the announcement has happened recognizing it’s still early days?

Stuart Levings

Yes, Geoff, it’s Stuart here. Thanks for the question. Certainly, we did see a spike right before the actual cutoff date for the new qualifying rules and that was bit of a surge. And we typically do see that as in past changes before the same thing. It doesn’t really last and it certainly has gone back to normal now. And I don’t think I would say we have seen any additional changes in behavior since then, but to your point, it’s still pretty early on. So, it will take some time to work its way through.

Geoff Quan

Okay. And just my second question, I know you made some comments about the China Oceanwide deal, just was curious if you had any discussions with them. And also just in terms of approvals they need out of Canada, I don’t know if you are able to respond, but is it just with respect to OSFI and competition bureau or anything along those lines?

Stuart Levings

Yes. So to your first point of your question, no we have not spoken directly with them. It is, as you know, a transaction of our major shareholder. But as far as approvals are concerned, it would require essentially the Minister of Finance approval in Canada, which sort of goes through an OSFI application and with the recommendation to the Minister of Finance and that would be required here.

Geoff Quan

Okay, great. Thank you.

Operator

And your next question will come from the line of Paul Holden of CIBC. Please go ahead.

Paul Holden

Thank you. Good morning. Given that regulatory capital requirements are going up January, when would you expect these potential rate increases to become effective?

Stuart Levings

Paul, the best answer will be Jan 1, but obviously, it depends on how the industry responds. There are certain areas that we ourselves may lead in terms of pricing changes and that would then be within our control as something we would see effective Jan 1. But there may also be other areas of pricing that are not as easy to lead, but certainly we are of the view that the industry will respond rationally as they have in the past, again with capital changes. And therefore, I expect pricing to be responsive. I am not sure it will be Jan 1 specifically, but early New Year would be ideal.

Paul Holden

And I assume you would issue a press release if you were to go ahead with the rate increases then?

Stuart Levings

We haven’t typically press released rate increases in the past. I think you will see it in the media generally, because it is certainly something that gets picked up and discussed. But we have not been of the practice of press releasing any changes in pricing ourselves. It would be something we would discuss normally on the quarter. And I think as I said, with the way the media is very focused on mortgage rule changes and mortgages in general any change in pricing and the industry I suspect will be discussed in the media.

Paul Holden

Got it. Okay. And then as we think about these higher capital requirements and starting with high LTV has there been any updated thoughts or estimates with respect to how much required capital could increase? You previously suggested for supplemental could be an impact of 10% or 20% base. I am not sure you provided a number or not, but any updates there would be helpful?

Philip Mayers

Okay, Paul, it’s Phil. I mean, in our slide deck, you do see that we do provide the one slide that includes the comparison of the total asset requirement between the old framework and the new framework and from that you can effectively see the outlined box demonstrates the amount of capital that would be required for an increase. But it’s important to note, any increase in the premium reduces the amount of the increase in the capital, because capital is really the equivalent of total asset requires minus premium liabilities consisting primarily of unearned premiums. I think the level of capital changes by loan to value. The good part is that the required capital is largely unchanged for a 95% loan to value, but the amount of capital increases as the loan to value decreases. So I think overall, we could see an increase in capital for new business, specifically in that range of 15%. But that’s something that the guideline from OSFI is not finalized. There was a comment period, there is a potential for further adjustments to the capital model and we won’t be able – won’t be in a position until the final advisory is issued by OSFI to determine the final impact on capital. I think the other additional thing to note there is, we have obviously prepared ourselves for contingencies and/or comments that we expect to be compliant is inclusive of any potential impact from these new regulations.

Paul Holden

Okay. And then with respect to the portfolio insurance, really I guess low LTV in this case, I know your prior graph on that had suggested that it might be 2x to 3x higher in terms of capital requirements, is that still the case?

Philip Mayers

That’s still the case. I mean we are still awaiting the finalized version. I think certainly, we have made some commentary around that, around the total asset requirement or expectation would have been that it would have decreased more if the loan to value decreased and that’s really an ongoing topic of discussion within the industry and the regulator. So once again, we are waiting for the final guideline. But that is certainly something that has been a topic of discussion.

Paul Holden

Okay. And I mean you keep emphasizing waiting for the final guideline, is there anything particular in your commentary or from other industry participants that you are aware of that would result in a material change to what’s been proposed?

Philip Mayers

Well, I think we certainly have made representations and I think our representation is probably similar to those of other participants. And I think we are awaiting the response to those. Having said that, we are prepared to manage under the requirements as is, but to your point, to the extent of capital for portfolio insurance increases 2x to 3x, that clearly will be reflected in the price. And back to Stuart’s comment, portfolio insurance is one of those areas that is a risk based pricing that’s unique to each lender based on their portfolio characteristics and that would be an area that we will be looking to move forward with price changes early in the New Year.

Paul Holden

Okay. That kind answers part of my next question I was going to ask, which is can we use those kind of guidelines for higher capital requirements as to what price increases we might see for January, so the answer on portfolio insurance is clearly, yes, is the answer on the transactional insurance the same, so roughly a price increase of 15% or so?

Philip Mayers

I think that’s a good proxy. I think, but the one thing to remember is that any increase in price reduces the required increase in capital. So there is a kind of a relationship between increase in price and the ultimate increase of required capital. But I think 15% is a reasonable proxy. It will vary by loan to value, based on the capital for the specific loan to value category.

Paul Holden

Okay, that’s helpful. Thank you. And then Stuart, you mentioned potential opportunities in portfolio insurance through your private MI subsidiaries, so that’s an interesting comment and I don’t think something we have seen in the past in the Canadian marketplace, so maybe can you elaborate just a little bit on how that might work in terms of private type guarantees that you could provide to lenders?

Stuart Levings

Yes. Paul, what we are looking at here is, there is obviously now some demand for insurance on product that has been eliminated, in particular the low ratio refinances. And that would be something that we were quite happy with the risk before. We would be happy to continue to ensure that risk if we were able to do so. And that would be doable potentially in a non-government guaranteed entity such as the one we have. Obviously, there is a couple of things we would need to think through in terms of overall market demand for that. We would need to get it rated and capitalized and rated. We would need to get a couple of additional regulatory approvals in terms of being able to operate around the country. But it’s something that we are evaluating and working on a business plan for right now. In the future, should risk sharing come to play, it might be another area of opportunity in terms of helping lenders with the first loss if that’s the way government goes, a portion of such an arrangement.

Paul Holden

Okay. And any kind of ballpark figure on what percentage of total bulk insurance refinancings has accounted for historically?

Stuart Levings

It varies again by lender. I think overall, when you look at our assessment of the impact, we sort of talked about a 25% to 35% impact roughly. The majority of that would be refinances. There are very, very few investor loans, generally speaking. So that gives you a good proxy of roughly how much it represents.

Paul Holden

Great. Thank you. That’s all the questions I had.

Stuart Levings

Alright.

Operator

And your next question will come from the line of Tom MacKinnon of BMO Capital Markets. Please go ahead.

Tom MacKinnon

Yes. Thanks very much. I was looking at the pro forma MCT going up by 2 points quarter-over-quarter and that translates into about $50 million in additional excess capital generated just in the quarter itself. Now, if we were to look forward and we assume that’s increased capital requirements for new bids, but if you had a corresponding price increase to offset that, then how should we look at capital generation, especially given the fact that excess capital generation is accelerated, generally when your origination volumes are slowing or declining, so how should we look at that given that you have kind of given this guided to reduction in transactional volumes for next year?

Philip Mayers

Yes. I think Tom, that’s a great point; I think you hit on many of the factors that impact in capital generation. One of those things that I would like to note is that with the transitional provision in place for legacy portfolio insurance as well as legacy extended amortization mortgages, the capital related to those two blocks of business that we call as of December 31, 2016, is unlikely to decrease in 2017 and probably won’t begin to decrease until the second half of 2018. So what that means is, that you have got a segment of your business that as your – the book ages, the capital is remaining the same. And therefore that will change the capital generation pattern somewhat and will largely offset the benefit of writing a lower level of new business. So – but having said that, we still expect earn-ins to be the key source of capital and we will expect that over time you will continue to see an upward accretion in the MCT ratio. And I think with a MCT supervisory target of 150, clearly we will be setting an internal target, which we will be doing as part of our overall own risk and solvency assessment and thereafter we will be operating above that. So those are decisions that we are evaluating in light of the draft advisory and we will be looking to finalize once the advisory itself is final.

Stuart Levings

Another point I would add to that Tom, is to your question on the price increases. Yes, we get those early on, but of course it takes a while for that to earn through into the equity, which then becomes capital available. So it’s not an immediate offset to capital required.

Tom MacKinnon

Okay. And then on your reduction in transactional, 15% to 25% for next year, if the impact is really someone able just to get a home say, or get a mortgage 20% lower than what it is right now and then they would qualify, if everyone of those that are affected by that right now chose to do that, the math would suggest only about a 7% decline. So in your math that gave this 15% to 25% decline are – what were you assuming in terms of people who were not going to buy a home at all then that were qualified in 2016?

Stuart Levings

Yes. Tom, I mean as we noted in our comments, there really is a degree of people that would be closer to the limit and those that would be right out at the max, if you will and beyond. And in our assessment we didn’t assume that everyone would be able to just find a cheaper property. To your point of view at the max before, you would now be looking for a 20% cheaper property. If you were already targeting a $300,000 property that doesn’t leave a lot of room for other options. So we took a view that if you were within 2 points of beyond the max, you would probably only need to look for a property between 5% to 10% cheaper and that we felt was more doable. So we took perhaps a somewhat conservative view, there is definitely upside to our estimate, but we believe that those people have a greater chance of finding a cheaper property than those people who would look for as much of a 20% discount in the price.

Tom MacKinnon

Okay. And then one final point, I guess is this isn’t the first time that mortgage insurance rules have been tightened. We used to be able to get 40-year amorts now you can get them – now they are down to 25. That is almost about the same kind of impact. But over those couple of years, when we had that kind of roll through, we really didn’t see significant declines in terms of transactional business generated. Am I correct in that assessment? And why do you think it might be significantly different this time?

Stuart Levings

Well, you are correct in the sense that the market eventually recovers and that’s again pretty much what we were saying here is that this impact of 15% to 25% is really our view for 2017. Beyond that, we do fully expect that borrowers will adapt and the overall market adapts and you will see that recovery again. I think the one difference is here, of course, is the 40% to 25% didn’t happen overnight. It kind of stepped down 5 years each time a change was made. This one is an overnight change of roughly 220 basis points of an additional shock, particularly on the high ratio side now. And that will have a bit more of a prolonged effect in the market, but I fully agree with you that, long run we too would expect this will play out and eventually recover.

Tom MacKinnon

Yes. And if I could squeeze one more, this is all based on posted rates as posted by banks. So, it’s not a regulatory rate that comes from the government, right?

Stuart Levings

That’s correct.

Tom MacKinnon

The posted rate is surveyable [ph] for banks. So it’s not something that the government regulates. So, it’s really in the banks’ control here as to what they are going to do with posted rates. Would we think about that or is that the first point?

Philip Mayers

Yes, I know. I mean, I would say that right now you are correct it is the Bank of Canada’s benchmark rate, which is the mode of the big banks’ posted rate. That’s the way it is today and certainly that could be influenced by changes in the big bank rate. But it’s not to say that the Bank of Canada couldn’t later decide to have their own rate which would be then disconnected perhaps from that rate. So who knows where this goes in the future? I think for now that’s the way it is set up and it could be influenced by changes of the big bank posted rate, yes.

Tom MacKinnon

Okay, thanks.

Operator

[Operator Instructions] And your next question comes from Graham Ryding of TD Securities. Please go ahead.

Graham Ryding

Hi. I just wanted to follow-up on the – your comment about opportunity perhaps on the private mortgage insurance side. My understanding is portfolio insurance is used by a lot of non-bank lenders so that they can access CMHC securitization. So, is your assumption when you said it could be opportunities to sort of offer private portfolio insurance that they find other financing channels outside of the CMHC?

Stuart Levings

Yes. Graham, I mean, obviously, what we are looking at here is a partnership where this is something that would need to work with both of those lenders and other parties that could help to facilitate a private securitization market. So we are basically offering as an opportunity here to continue to ensure those kinds of loans. It will be, as I said earlier, part of our development of our business plan is assessing the level of demand, is it economically feasible even to have a private securitization market and that would take work from a number of parties, not just ourselves.

Graham Ryding

Got it. That’s helpful. The pro forma capital ratio that you have provided last couple of months, is it correct that, that does not include any supplementary capital component?

Philip Mayers

That is correct. I mean, the supplementary capital is applied prospectively commencing January 1, 2017. So, on our existing book in insurance mortgages, there is no supplementary capital that will be required.

Graham Ryding

And then if it starts in 2017, how many years is it realistic to think that if it’s on new insurance written that it applies before really it gets fully embedded into your overall capital requirements. Is it sort of a 3-year, 4-year process until it gets fully baked in?

Philip Mayers

Yes, I think its 3 years to 4 years before you get to sort of a mature book that has the supplementary capital applied to it. The other thing of note is that supplementary capital is dynamic in terms of the calculation of our specific markets above the OSFI prescribed threshold. So, there is potential that you could see markets being added to the supplementary capital. You could see markets that no longer require it. Right now, we estimate approximately 35% of our transactional business would be subject to supplementary, but that percentage could change and that could then impact the timeframe over which you get to a mature state.

Graham Ryding

Okay. And then your comment about roughly capital going up by 15% that’s – am I interpreting that correctly that, that’s sort of a fully baked in capital requirement in 3 to 4 years?

Philip Mayers

Well, that is really as it relates to new business. So, yes, on the overall book of business, it will take some time before you see that full impact, but clearly our new business, that’s the comment on new business relative to the existing standards.

Graham Ryding

Okay, that’s helpful. And then just last one, the expense ratio ticked up slightly in the quarter, is there any color behind what drove that?

Philip Mayers

Yes. I mean, we reassessed some more assumptions around the accounted for share-based compensations and we made a one-time adjustment to the remaining life assumption within that and that drove a $2 million one-time item. So that is really the color. I think outside of that, our expenses continued to be relatively consistent.

Graham Ryding

Thank you.

Operator

There are no further questions. I will turn the call back to Mr. Levings.

Stuart Levings

Thank you and thanks again for joining us today. We do appreciate your time. As a reminder, we will be hosting our 2016 Investor Day on December 7 where we will cover these topics along with a few others in greater detail. This concludes our third quarter 2016 earnings call. Thank you for your participation. And you may now disconnect.

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