5 reasons I would avoid Genworth Mortgage Insurance Australia shares

I think Genworth Mortgage Insurance Australia's (ASX:GMA) prospects are mediocre.

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Good investing is as much about picking winners as it is about avoiding shares that could be likely to struggle.

I think Genworth Mortgage Insurance Australia (ASX: GMA) could be one of the strugglers, and here are 5 reasons I would avoid the company today:

  • Banks are increasingly self-insuring. This has led to a decline in demand for Genworth's business, although the decline appears to have stabilised recently.
  • Lending standards have tightened. This has led to fewer loans with a high loan-to-valuation ratio (LVR), which again directly reduces the need for lenders mortgage insurance.
  • Losses are increasing. Genworth has recently been wearing some unpleasant, although still quite minor, losses in Queensland and Western Australia. Revenues falling at the same time as losses are increasing does not make for a happy shareholder.
  • There is a catalyst for worse losses ahead. Although Genworth appears to have a 'floor' on its value with net tangible assets of $3.84 per share, well above the current share price, losses may intensify over the next couple of years as borrowers switch from interest-only to principle and interest loans. Additionally, house prices have fallen recently, potentially reducing demand for new business and/or increasing delinquencies, although the link between falling house prices and loan delinquencies is tenuous.
  • Risk of lightning bolts from heaven. I'm not sure what else to call it, but just maybe the housing market blows up, Genworth goes broke, and your investment is toast. While it may appear well capitalised from a regulatory perspective I'm not convinced it can weather truly adverse circumstances. This unlikely scenario is probably why the company trades at a discount to its net tangible assets.

Having said all that, there is also a compelling thesis for owning Genworth. If you believe that loan delinquencies won't get much worse and that a housing market collapse is unlikely, then Genworth may look like a very good business in a few years' time.

By buying back shares at a discount to its net assets, the company is literally buying $1.35 for every $1 it spends on shares.

Currently 6% of the company's shares are short-sold, according to ASIC, which suggests a reasonable percentage of the market is betting against Genworth. I'm currently unable to resolve my thoughts into a convincing thesis either way, although I do find the situation interesting and it is one I will continue to keep an eye on. Unless you have a solid grasp of the market and the industry however, I would suggest leaving Genworth on the shelf.

Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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