Genworth MI Canada Inc. (OTCPK:GMICF) Q2 2016 Earnings Conference Call August 3, 2016 10:00 AM ET
Jonathan Pinto – Vice President, Investor Relations
Stuart Levings – President and Chief Executive Officer
Philip Mayers – Senior Vice President, Chief Financial Officer
Geoff Kwan – Capital Markets
Tom MacKinnon – BMO Capital Markets
Paul Holden – CIBC
Graham Ryding – TD Securities
Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Genworth MI Canada Inc. 2016 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time. [Operator Instructions]. I would like to remind everyone that this conference call is being recorded today.
I will now turn the conference over to Jonathan Pinto, Vice President, Investor Relations. Mr. Pinto, you may proceed.
Good morning, everyone and thank you for joining Genworth Canada’s second 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?
Thanks, Jon. Good morning, everyone and thanks for joining our second quarter earnings call. We are pleased with our strong results this quarter, particularly our loss ratio which continues to reflect the prime quality of our insurance portfolio and ongoing resilience in oil producing regions as well as strong momentum in premiums earned due to premium rate increases at larger recent books of business. For the quarter, we delivered net operating income of $99 million, up 8% over the prior year period. This generated an operating return on equity of 12% and diluted operated earnings per share of $1.07. Premiums written totaled $249 million, up $44 million or 21% over the prior year period, driven largely by a substantial increase in the volume of portfolio new insurance written.
Premiums written from our transactional insurance volumes declined $13 million or 7% over the prior year period. This decline was primarily due to our targeted underwriting actions in select markets and a slower housing market in oil producing regions, partially offset by a higher average premium rate driven by the June 2015 rate increase. We expect the demand for portfolio insurance to soften in the second half of this year due to the implementation of the purpose test rules effective July 1. Therefore, as noted in our MD&A, total premiums written are likely to be lower this year compared to last year due to the impact of our underwriting actions on market share along with the ongoing pressure on first time home buyer affordability which impacts the size of the transactional insurance market.
As previously noted, we are pleased with our loss ratio which came in at 21%, down three points over the prior quarter and below our expected loss ratio range for the year. We ended the second quarter with an MCT ratio 233%, down one point over the prior quarter. While this level is moderately higher than our targeted range of 225% to 230%, we believe it remains appropriate and reflects our view of the current economic environment including some flexibility as we work through the new RC capital test under development for 2017. Our capital priorities remain focused on supporting our core business volumes and ordinary dividends.
As part of our ongoing capital management strategy, we will revisit these priorities once we have the necessary clarity on the updated RC capital test. Our book value at $38.23 per share continues to grow, up 6% over the prior year period driven by ongoing profitability. When I reflect on the housing and macroeconomic environment, it’s clear that many of the themes evident in the first half of the year continue to prevail; constrained economic growth, pressured commodity prices and an ever diverging regional housing market with meaningful growth in the greater Toronto and greater Vancouver markets versus the rest of the nation. We expect housing markets to remain fairly stable in the second half of the year while the GTA and GVA will likely see continued house price appreciation driven primarily by strong job growth, foreign investment and immigration. These increases are largely concentrated in single family detached homes with the price point beyond our average first time homebuyers reach.
That said, we recognize that there is some contingent to our serve market, putting pressure on first time homebuyer affordability and we welcome the government’s permission on the task force solutions to these issues. Our typical first time homebuyer continues to be fiscally prudent as demonstrated by loan and credit – receives evidence in the mortgages insured this quarter. Average credit scores in the second quarter remain high at 754 up four points over the prior quarter. The median house price for insured loans decreased modestly due to shifts in regional mix while the gross debt service ratio remains stable and well below the industry maximum. In terms of outstanding delinquencies, we saw a decrease of 4% compared to the prior quarter primarily due to seasonal trends.
Year-over-year, delinquencies increased by 18% largely driven by Alberta and the Prairies partly offset by an improvement in BC. New delinquencies net of cures improved by 216 quarter over quarter largely due to seasonality with decreases in all regions except the Prairies. As expected, the current economic trends in Ontario and BC is helping to account some pressure from oil producing regions. In addition, we continue to see an improvement in Quebec as new delinquencies net of cures down 75 over the prior quarter. While oil prices have seen some stability over the last three months, we recognize that the oil producing regions have suffered significant job losses and will likely see increasing levels of mortgage delinquency over the next 12 to 18 months.
On the other hand, some of the more traditional industries such as lumber, agricultural and manufacturing continue to fare better and have helped to soften the impact on our employment. This strength together with other mitigating factors including severance packages, employment insurances, evolving spending habits and lifestyle choices account for some of the resilience we see in incredible performance to-date. That said, second quarter new delinquencies net of cures in Alberta are up by 82 over the prior year period and we expect this trend to continue during the balance of the year. We also expect house prices in Alberta to soften further, but slower than our estimated range for the year of approximately 5% to 10%. Based on these market observations and our loss ratio performance year-to-date, we are reducing the high end of our estimated loss ratio range from 40% to 35% with a revised full year estimated range of 25% to 35% for 2016.
With that, I’ll turn it over to Phil for a deeper look at our financial results.
Thanks, Stuart and good morning. Our strong loss performance this quarter translated into net operating income of $99 million. This was higher sequentially by $7 million as a result of modestly higher premiums earned and a three point improvement in our loss ratio to 21%. As Stuart noted, total premiums written were $249 million inclusive of $170 million from transactional insurance. Transactional premiums written decreased by 7% year-over-year and 15% lower in new insurance written. The average premium rate was 9% higher reflecting the full effect of the 2015 price increase. We also wrote almost $26 billion of portfolio insurance in the quarter and realized $78 million in premiums written. These portfolios have a very strong credit score profile with an average loan-to-value around 65% which has resulted in a lower average premium rate as compared to the prior quarter.
As expected, premiums have improved modestly sequentially to $158 million which represented a 10% increase year-over-year. This growth should continue throughout 2016 and into 2017 due to the higher levels of premiums written in recent years. Despite continued pressure in the oil producing regions, our loss ratio for the quarter was 21% on losses and claims with $32 million. Losses were lower by $4 million compared to the prior quarter as new delinquencies net of cures declined by 216 as discussed by Stuart. We continue to focus in expense management and achieve an expense ratio of 19% and $30 million of total expenses, consistent with company’s expected operating range of 18% to 20%.
Overall, underwriting income was $95 million which represented an increase of $7 million sequentially. [indiscernible] $44 million of interest in dividends from our investment portfolio. This was modestly higher sequentially by approximately $3 million due to the modestly higher level of invested assets and higher dividend income. Overall, net operating income of $99 million generated an operating return on equity of 12% and a fully diluted operating EPS of $1.07. Our diluted book value per share grew by 6% year-over-year and now stands at $38.23, inclusive of AOCI. Premiums earned have increased from six to eight quarters and our single upfront premium models gives visibility into future premiums earned from the $2.1 billion unearned premium reserve.
We expanded the disclosure in the management discussion analysis around the expected level of premiums earned. Assuming that there are no significant changes in the premium [indiscernible] incurred, premiums that are into the second half of 2016 should consist of $295 million to $310 million for the existing unearned premium reserve plus further amounts to be earned from premiums written over the remainder of 2016. In total, this should lead to an increase in premiums earned of 5% or greater for the full year.
In addition to the growing trend of premiums earned and the strong portfolio quality in geographic diversification, have contributed to solid underwriting profitability. While the number in new delinquencies net of cures decreased sequentially, the average reserve for doing – increased by 6%. This was primarily due to a higher Alberta mix with higher average balances and the modest impact from home prices in Alberta and other oil producing regions. It is important to note that mortgage insurance is not typically extent to physical damage beyond normal wear and tear and therefore, direct damages from the [indiscernible] fires are not covered by mortgage insurance. In conjunction with our lenders, we are supported Genworth insurance borrowers and – by allowing them to defer up to six months of mortgage payments. In light of the potential for extended for closure and sales periods in the – we have modestly increased our loss reserves.
With a loss ratio of 22% in the first half of 2016, we have revived our loss ratio range to 25% to 35% for 2016. This is after providing for the potentially higher loss ratio in the second half of 2016 as noted by Stuart. Our investment strategy continues to be focused on high quality fixed income investments. As a result, - $6.1 billion investment portfolio is relatively unchanged except for a modest increase in our allocations preferred share given the attractive dividend yields above 5%. That being said, our portfolio yields stands at 3.1% in our portfolio duration of 3.7 years. We’ll continue our efforts to maintain or improve our portfolio yield over time through proactively managing the portfolio mix within or risk -.
Our Minimum Capital Test or MCT ratio was approximately 233% and we held $166 million of holding company tax liquid investments at the end of the second quarter. These reflect our strong profitability and the benefits from partially hedging interest rate risk, offset by the sequentially higher capital usage to support transactional and portfolio insurance volumes this quarter.
In light of the pending new capital framework, we have continued to operate moderately above our targeted operating range of 225% to 230%. A draft guideline for the new capital framework is expected to be published in the early fall with a targeted implementation date of January 01, 2017. Based on our extensive stress test for severe –event, we believe that we’re adequately capitalized at the current capital level. The new framework is expected to be more recessive and will likely include additional risk elements such as credit score, credit outstanding insurance balance and remaining amortization.
As well, OSFI has announced the introduction of supplementary capital requirements for new businesses under – cities where the house price to incommensurate exceeds our prescribed threshold. Based on this metric, the metropolitan areas of Vancouver, Calgary, Edmonton and Toronto currently exceeds their respective proposed threshold values by significant margins. These cities currently represent approximately 35% to 40% of our transactional new insurance written. As a result, new insurance written in these cities will likely attract supplementary capital starting January 1, 2017, if there is no change in the proposed threshold values.
- we expect the mortgage insurers may need to introduce higher premium rates for insurers mortgages in these affected cities. Overall, we are no insufficient to fully assess the impact of the new capital frameworks in the proposed supplementary capital until after the publication of the draft framework. As a result, we expect to maintain our MCT ratio moderately above 225%. In closing, we remain confident that our track record of solid profitability will continue throughout 2016 and into 2017.
I will now turn the call back to Stuart to conclude our prepared remarks.
Thanks, Phil. We remain focused on that which we control, prudent underwriting with targeted actions over dependent regions, prime quality, first time homebuyers purchasing homes well 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 continue to support lenders across Canada employing our dynamic risk underwriting technology and judgment to ensure we remain within our risk appetite while maintaining the needs of our customers with the best in class service experience. Thanks for listening. That concludes our prepared remarks. I’ll now turn the call back to the operator to commence with the Q&A.
Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. As a reminder, the conference is being recorded for replay purposes. [Operator Instructions]. Your first question comes from Geoff Kwan of RBC Capital Markets. Please go ahead.
Hi, good morning. The first question I had was I know you talked a fair bit about what’s going on in Alberta, just wanted to may be go a little bit deeper in terms of the prices have recovered a little bit, just from what you’re seeing right now, we haven’t seen really a lot out of Alberta right now. Are you expecting to still see things accelerating in terms of on the loss side over the coming quarters or are you seeing things, may be things aren’t as bad as what you initially thought hence why you brought the loss ratio guidance down a little bit? Just wanted to get a little bit more color on that.
Geoff, good morning, it’s Stuart here. Thanks for the question. Yes, and yes a little bit. We are revising the loss ratio range because we’re happy through the year. We know what we got in the bag and we recognize the environment in Alberta has been more resilient than we initially expected therefore for the latter half of the year, while we are expecting to see both pressure on losses, we’re likely to not get above our upper range now of 35%. The environment in Alberta is obviously volatile still. We do have oil prices that are moving around.
We know there’s a lot of unemployment that has occurred, we haven’t seen the full fallout from the credit side yet, but our expectation is that with normal seasonal pressure that always picks up a little bit into the third and fourth quarters, in conjunction with a lot of the measure that people have been taking to stay current – potentially as lot of them are time bound, we are expecting to see higher losses continue to come out of Alberta in the second half of the year. As I noted in my comments, new delinquencies were up quarter-over-quarter and year-over-year in Alberta and we expect that to continue. So, yes we see a bit more pressure and losses in the second half of the year which will take us north of where we are in our loss ratio, but we are confident enough that at this point of the year, we’re not going to see the high end of our original loss ratio guidance, hence the change.
Okay. And just the second question I had, I know we’re only one month into Q3 and the timing around the bulk insurance transaction can vary at any point in the quarter, but when I look back historically, when we exclude this past quarter you had a bit of the spike, were you on average writing may be about $20 billion -- $20 million a quarter in new premiums written on the bulk side? With the rules changes that have taken effect last month, are you thinking that the demand is going to be cut by half, some other number, just wanted to get a sense on where you think it will play out in the coming quarters?
Yeah, Geoff, generally speaking the bulk really comprises two main areas, one is big bank bulk and the other is sort of your mono line bulk portfolios. The big bang bulk is where we think demand will soften as a result of the changes whereas mono line bulk demand will probably continue as usual. And then in that sense, we would expect to see that sort of level continue to the third and fourth quarter. So, in line with previous years subject to market size etcetera.
And then sorry - how much would have been kind of the bank now that you expect to fall off, if it was that you’re writing 20 million in new premiums this quarter, how much that would have been kind of the bank related?
It varies quite a bit. So the big bank demand as you noted is volatile, it changes from quarter-to-quarter. So in the past, you’ve seen some quarters where big bank portfolio insurance was a big proportion of our overall bulk and in other quarters it’s a much smaller. So it’s hard to give you any specific guidance in terms of it will be half of that run rate or three quarters of that run rate. But I think I would say that we’re typically looking at around the $3.5 billion a quarter in mono line in terms of new insurance written, and then depending on the average premium rate that you could work on that to look at what we would expect from a premium written point of view.
Okay. All right. Thank you.
And your next question comes from Tom MacKinnon of BMO Capital Markets. Please go ahead.
Yeah, thanks very much. Good morning everyone. May be this question should be directed to Phil but Stuart certainly pipe in if you think you have something to add. Just with respect to the supplementary capital, I realized that it doesn’t imply to non-deposit taking institutions which you do know you’re above these thresholds in Calgary, Edmonton and Toronto and Vancouver and Victoria. How likely do you think that the new framework will adopt these supplementary capital thresholds? What do you think the MCT would increase by if it did? And what do you think the kind of price increase we would need to have to offset that?
Hey Tom, it’s Phil. The supplementary framework will apply to mortgage insurers. Back in December when OSFI made the announcement, they did note that it would likely also apply to mortgage insurers and while they haven’t published what the level of supplementary cap will be for mortgage insurers, the same triggers that would apply to IRB banks would also apply to mortgage insurers as far as we understand it. With respect to the MCT level, that’s still something we would expect to be published as part of the new capital framework in the fall. And at this point in time, we would be speculated if we noted what the expectation would be. So, it’s really premature at this time to comment on the level of capital, but certainly it’s something that we would expect for the disclosures by the regulator in the early fall. And following that, obviously, we’d have to set pricing. It’s clear that capital makes up a large portion of the premiums and given that capital is there to protect policy holders in the event of a tail event, we will have to wait to see the levels of supplementary capital and certainly I presume the industry will review pricing at that time.
And could you remind us how often the industry can really actually look to increase prices or how to understand that thinking, can we look at that every year now going forward?
Definitely, there’s a formal price review that’s required on their off – regulations meet annually, so I would expect as part of the annual press review for 2016, supplementary capital and the new capital framework will be considered.
And your next question will come from the line of Paul Holden of CIBC. Please go ahead.
Thank you. Good morning. I guess follow up question on the regulatory capital requirements or the new regulatory capital regime. Just wanted to make it clear, in terms of that supplementary capital, it’ll be for new premiums only not for existing insured risks? Is that correct, as proposed?
That is correct. It’s continuing to be perspective, starting January 1, 2017.
Okay. And I have a question for you on the premiums earned guidance. So you continue to guide to roughly 5% growth year-over-year for all of 2016, but first half is up around 9%. So just wondering why growth would look fairly slow in the second half of the year?
I think if you read our guidance closely it says 5% or greater. So certainly we would necessarily expect it to – from the first half of the year it’s more like 9% it may not see a full year 5% but certainly 5% would be the lower bound.
And then in terms of the pressures you’re picking up some extra investment yield and different in the income there, with the 5% of the portfolio allocated to pressures there, are you kind of at target or is there capacity to go higher?
We continue to review sort of our investment optimization. We certainly see it something that we would gradually increase our preferred shareholding. We believe there may be some incremental room but that’s only subject to single name limits. One thing we recognize is that the investment grade space for preferred shares is relatively concentrated. So we would take into consideration or single name exposure to any one issuer as part of our strategy. So there is some room to grow but certainly I think we’ve done the bulk of the purchases today.
Okay. And then part of your MD&A discusses lower transactional volumes probably attributable to a change in underwriting strategies in select markets. May be you can talk about which markets those are specifically and what you’ve changed in terms of your underwriting?
Yeah Paul, Stuart here. I think it’s really nothing new in terms of directional or action, it’s an ongoing approach to being an – more prudent in oil exposure regions. So Alberta, predominantly to some extent in Canada, but really it’s around making sure that we’re – about the margins or risk in those areas and taking because it will be responsible underwriting actions. That has really driven some share compression in those markets particularly. Our major competitor has apparently a – view on the risk appetite there despite published our positions to the contrary in terms of the risk in those markets. But in any event, we have taken what we think to be prudent responsible actions there and in addition to the fact that those markets are obviously seeing smaller volumes of resell transactions and that has predominantly driven the smaller flow or transactional – for ourselves.
Okay. And if we were to take a national view, would you say there’s any material change in market share or are you holding it relatively constant on a national basis?
On a national basis, we’re probably down a little bit. We would estimate – around approximately 30% right now, so couple of points overall. At the same time, we’re looking at areas like Ontario BC as very opportune markets, very strong performing economies and certainly an area that we’re very comfortable taking on more exposure and very encouraged by what we’re seeing Quebec right now from a performance point of view as well.
Okay. And then final question is related to the $100 million credit facility you took out during the quarter, what would be some potential uses of that capital?
Paul, it’s Phil. We see the credit facility as financial flexibility and we do not see it as long-term financing, we see it essentially bridge financing. So to the extent we saw opportunity that required funding, where we had long-term funding that may be – by a couple of months, that would be of potentially use. But we think it’s a good practice to build financial flexibility and we view it in that light.
Okay. So this one will be related potentially to acquisitions, it’s more ongoing operations?
It’s not earmarked at this time for any specific activity. It’s more in light of build-in financial flexibility to ensure that we’re nimble and whether this is core business opportunities in the MI business, for example, you saw the levels of bulk insurance as we did last quarter. If in the future other opportunities were to present themselves in our core business, and it require incremental capital, we certainly have long-term plans to fund that capital. We may use the facility for short-term need but it’s clearly not intended for a long-term portion of our capital structure.
Okay, thank you for your time.
[Operator Instructions]. And your next question comes from Graham Ryding of TD Securities. Please go ahead.
Hi, good morning. My one question just a follow-on on the transactional business, specifically the markets BC, Ontario and Quebec year-over-year they were either from new insurance written perspective. There they are flat or down and from your commentary it sounds like that’s not deliberately you’re pulling back. So is that a reflection of just affordability in those markets making I guess the size of first time homebuyer market such that there wasn’t growth year-over-year?
Yeah, Graham. It’s Stuart here. That’s our estimation right now I mean it’s hard to say for sure until you get good data from the full industry, but our estimation is that while activity is definitely up in those markets, the actual first time homebuyer leveraging high ratio insurance seems to be down. That could be a function of the fact that in order to service or debt service a mortgage, they can’t afford a 5% or 10% down payment to cover that mortgage payment. So they are forced to find more whether that’s from gifts from parents, whether that’s through other forms of down payment source, the reality is our exposure or our estimation is that the actual volume of high ratio buyers in those markets is at a lower level than we’ve seen it historically and that’s a direct reflection on the affordability pressure.
Okay. Great. And then just on the portfolio insurance side, have you seen since the July 1 regulatory change, have you seen a drop off in demand in your portfolio insurance?
In the big banks space as we’ve said before, yes definitely.
Okay, great. And my last question just there was an unrealized impairment loss, any color around what that was, $3 million?
Graham, it’s Phil. It was $2.5 million sort of impairment related to a Brazilian construction company. We continue to believe that current values are below what we view the long-term value of that, that we took the impairment rather than sell the security. So rather small item.
Got it. Thank you.
And your next question will come from the line of Jamie – of National Bank. Please go ahead.
Yeah, hi good morning. Question is related to stress testing and recent news from OSFI around standardized banks that are on standardized approach and taking a more targeted approach to stress testing Vancouver and Toronto. How are you guys thinking about your stress test, you’ve talked about it in the past in Investor Days but has this caused you to revisit how you’re stress testing your portfolio?
Jamie, it’s Stuart here. No, not really. We’ve always stress tested the portfolio on a variety of scenarios including significant property corrections in Toronto, Vancouver, and in fact those levels that were referenced in the letter from OSFI are things that we’ve looked at ourselves. And all those scenarios we still maintain sufficient capital to pay all our claims. So it’s not new to us, certainly something that we would say is very severe tail event if it were ever to occur, but something that we have stress tested our portfolio against.
Okay, great. Thank you.
And since there are no further questions, this concludes today’s conference call. Thank you for your participation in Genworth MI Canada Inc. 2016 Second Quarter Earnings Conference Call. You may now disconnect.
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