This morning, shares of Genworth Mortgage Insurance Australia (ASX: GMA) opened up to 4.6% lower following the release of its first quarter report earlier in the day.
In an announcement to the ASX, for the three months to 31 March 2015 Genworth said its gross written premium (GWP) was 20% lower year-over-year at $127.7 million, whilst new insurance written (NIW) fell 17.2% to $7.2 billion.
Although the headline profit figure of $89.5 million was 29.2% higher than the prior corresponding period, investors appear to have seen through this. Indeed, excluding a $19.8 million after-tax mark-to-market gain, underlying net profit was flat at $69.7 million.
Genworth said its performance "reflects continued relatively stable economic conditions, characterised by relatively steady unemployment and benign inflation."
It said the fall in NIW and GWP was a result of a reduction in mortgage originations with Loan to Value Ratios greater than 90%, lower percentage of owner occupied mortgage originations and lower levels of mortgage origination growth in its customer base.
It also said half of the 20% reduction in GWP was affected by the timing of payment processing.
Are Genworth shares a bargain?
Like any insurance business, Genworth captures risk and mitigates it by issuing premiums and investing the float (or pool of premiums). It'll make money on both of these parts of the business if it's good at what it does.
During the good times, characterised by minimal claims (like now), insurance companies will do really well. However when uncontrollable external tailwinds turn on their head they can cause significant damage to an insurer's earnings base. This is why Genworth should always trade 'cheap' in a conventional sense.
More specific to Genworth is the risk of slowing – or even falling – house prices. Given it insures, arguably, the riskier loans (i.e. those with high LVRs) it would be directly in the firing line if property prices fell. In this respect, unemployment would likely be the catalyst. As unlikely as a house price crash may seem, investors need to aware of the implications.
An additional layer of uncertainty to Genworth is the source of its customers. Earlier this year, Westpac Banking Corp (ASX: WBC) – which accounted for 14% of Genworth's GWP – cut ties with mortgage insurers. Subsequently Genworth shares fell 23%.
Genworth today announced it had entered into a Request for Proposal with National Australia bank Ltd (ASX: NAB) for its lenders mortgage insurance contract. "The LMI business underwritten under this contract represented approximately 11% of GWP in 2014," Genworth said. A loss of business from NAB or Commonwealth Bank of Australia (ASX: CBA) could be significant.
Buy, hold, or sell?
Given the risk attached to a long-term investment in Genworth shares, investors must go in with their eyes wide open and demand a margin of safety to their estimate of the true worth of its shares.
