TBergin-2018 New York Idea Contest

Short:
Genworth MI Canada
TIM BERGIN
t i m @ o n b e y o n d i nv e s t i n g . c o m
@ o n b e y o n d i nv e s t
Genworth MI Canada Ticker: MIC Exchange: TSE
Financial Snapshot
Share price (as of 4/19/2018) $38.59
Shares outstanding (mil) 90.96
Market capitalization ($CAD bil) 3.51
Book value (incl. AOCI) 43.13
Price to book ratio 0.90
2017 ROE 13%
Dividend per share $1.88 Price target:
Dividend yield
52 week range
4.87%
$44.49 - $30.38
Substantially
Cost to borrow 2.50% lower…
tim@onbeyondinvesting.com 2
Idea Premise
The Canadian The balance Revenues are
housing bubble sheet is risky booked
has burst aggressively
• Prices are down 10% nationally • The company has $218bil of • Over 80% of premiums are
and 14% in Toronto from the outstanding mortgages insured recorded as revenue in the first
peak last spring 5 years
• $97bil for which ‘actual LTV’ is
• Sales volumes are down 20% greater than 90% • As house prices stop rising, more
year-over-year losses will occur and revenue
• The company has loss reserves
recognition should extend
• New “B-20” regulations have of only $119mil, and $3.9bil of
reduced affordability by 20% equity • Lower premium volumes and
slower revenue recognition will
mean much weaker earnings in
the future
Investment Summary
If the bubble has burst… If there is a (mythical) “soft-landing”…
the housing market crashes, and balance OR future earnings will be materially weaker
sheet risks could wipe out their equity. (I estimate down 66%).
The short is asymmetric

Downside: 20 to 30% Upside: 60 to 100%
The stock trades at 0.9x book (average price of 0.95x book since 2009).
ROE was 13% in 2017 (10% if you normalize the loss ratio) and they have averaged ROE’s of 11% since 2013.
Canadian Mortgages
Mortgages come with a short fixed interest rate period,
typically 5 years, and mortgage is amortized over 25 to
30 years.
Once fixed interest rate period is over, borrower needs
50% of Canadian
mortgages are up for
renewal this year!
to reapply – rate does not simply roll-over.

Mortgages are recourse, however, if homeowner files
for personal bankruptcy a mortgage shortfall becomes a
general unsecured claim and is fully dischargeable!
Borrower recourse
not as valuable as people
Mortgage interest is not tax deductible. think
Primary residence incurs no capital gains when sold.
Important Regulatory Changes
B-20 Regulation Rent control in big cities
As of Jan 1st 2018, borrowers have to prove Rent increases 1.8% in Toronto
they can afford a mortgage at interest rates are now
2% higher than current mortgage rates. restricted to: 4.0% in Vancouver
Reduces pool of buyers Airbnb use restricted to primary residence

only
Reduces affordability 20%
Canadian Mortgage Insurance
• Required for any borrower that puts down less than 20% Market Share
(i.e., >80% LTV)
• Insurer is liable for 100% of losses on default
• There are 3 insurance providers in Canada. The biggest player
is CMHC - a Canadian Crown Corporation. Genworth MI Canada
is the only publicly traded insurer (~ 32% market share).
If CMHC itself defaults, government MIC likely insures a weaker

covers 100% of banks’ losses pool of borrowers as banks
If MIC itself defaults, government hold 3.5% RWA vs 0% for
CMHC-insured mortgages. MIC CMHC Canada Guaranty
covers 90% of banks’ losses
Canadian Mortgage Insurance continued
Insurers don’t individualize price; a standard one-time Insurance Premium Rates
upfront premium is charged. Price considers LTV only. LTV New Rate
Prior rate
(Mar 2017)
Factors not considered in rates
Up to 90% 3.15% 2.40%
dwelling type, credit score of borrower, location, house
price, market conditions, etc. Up to 95% 4.00% 3.60%
90 to 95% ‘non- 4.50% 3.85%
traditional’
Is this a good way to underwrite risk?
Portfolio Insurance 0.81% 0.36%
Loan: $300k Insurance

Example: $300k loan with 5% down. Premium is 4%.
Bank pays $12k upfront to insurer and $12k is added
to borrowers loan and also to the insured amount. Mortgage: $300k + 4% x 300k 4% x 300k
+ interest
Underwriting at MIC
Genworth Canada has only 271 employees With their process, the banks’ perverse
incentives, adverse selection issues, how exposed
Most underwriting decisions are made quickly; are they to fraud?
◦ 85% of applications are processed in 4 hrs!
◦ 95% within 24 hrs
Industry expert estimates that 85% of

incoming applications are ultimately insured.
There are no loss reserves on insurance until a
borrower is 90 days delinquent, at which point
losses are estimated and a reserve is
established
Summary of Canadian Mortgage Insurance
Premiums are based on LTVs only
~ 85% of applications are approved Poor process!
No initial reserves are required
Banks have no ‘skin-in-the-game’ and

capture the benefits
Incentive misalignment!
No wonder almost 50% of Canadian mortgages are insured.
THE CANADIAN HOUSING BUBBLE
(Scary) Canadian Housing Market Statistics
House prices in Canada are 157% higher now than in 2003
In Median home price Median family income
2018: $500k $80.9k
% Increase in price
Statistic
(at peak)
Debt to disposable income 171% 114%
Consumer debt to GDP 127% 94%
Price to income ratio 6.25x 3.8x
HELOC debt to GDP 12% 4.5%
Year
Canadian HELOC Debt is a Problem
13.9% $235bil
Annualized growth
in HELOC debt
since 2000: in total.
Common uses: HELOC debt is floating rate, and borrower only

▪ giving down payments to children required to pay interest
▪ buying investment units HELOCs have no amortized repayment, but are

▪ investing in syndicated or private demand loans. If banks change amortization
mortgages paying 8 to 10% period to 5 years, monthly payments would
increase by 550%
According to the Bank of Canada, 40% of HELOC borrowers do not make regular payments that
cover both interest and principal.
Genworth’s Exposure to Condo Market
Condos are the only market in Canada where prices haven’t dropped.
80% of new home sales in Toronto were condos and almost 50% of condo buyers were investors.
20% of condo owners in Toronto and 17% in Vancouver spend more than 50% of take home pay
on shelter costs.
Condos are trading at sub 2% cap rates. They produce negative cashflow after financing costs. New
rent control rules mean that these units will stay that way for the foreseeable future.
Genworth has significant exposure Volume of 30% in Toronto

business in 40% in Vancouver
to this market. condos: 11% nationally
Media has Turned Bearish
Higher Interest Rates are Affecting Borrowers
“Nearly half of those polled (46 per cent) believe they’re

now $200 or less away from financial insolvency after
covering bills and debt at the end of the month. This was
one of the few areas in which Albertans, at 41 per cent,
came in lower than the national average.
Similarly, 47 per cent of respondents don’t believe they’ll

be able to cover all their living and family expenses over
the next year without plunging further into debt.”
Imagine what would happen if the Bank of Canada raises rates twice in 2018, as projected…
THE BALANCE SHEET IS RISKY
17
Balance Sheet Overview: Sufficient equity?
$CAD billion Key Elements for Calculating Losses:
Total insurance written 495
Total insurance outstanding 218 1 LTV
Transactional insurance 118
Portfolio insurance 100 2 Default rate

Equity 3.9
Loss reserves 0.1
3 House price decline
Examining the LTV of Transactional Portfolio
Upon default, in addition to losses on mortgage, MIC has to pay:
Borrowers missed mortgage payments: 5% of property value
MIC estimates in its Annual
Lawyers fees to foreclose and sell property: 5% of property value Information form that these
costs add up to 15%.
Repair costs, taxes etc.: 5% of property value
These costs help explain why severity ratios have averaged around 30% for the last 10 years, despite a
raging bull market in housing.
‘Actual’ In my analysis I add 15% to

reported LTVs to adjust for
Newly originated mortgages are underwritten at an average
LTV of 92 or 93%, which implies ‘actual’ underwritten LTV is
LTV: these costs actually 107 to 108%!
What Could Default Rates Look Like?
Today… house prices in Canada are 60% higher on a price-to-income basis than
any other time in its history. Debt has never been higher. Canadians
are significantly more levered than Americans were at the peak on every metric.
What is more likely?
Default Comments
Comparable
rate
Historical
default rates of 1% OR Fannie/Freddie 7% Only 17% with LTV >80% vs
100% for MIC
US Mortgage Insurers 17 to 21% Direct comp to MIC
What Could Default Rates Look Like? continued
Similarities between Ireland and Canada:
Long-run income
▪ On a price to income ratio, Canada is within 3% of the peak average*=100
overvaluation in Ireland.
Overvaluation relative to income

▪ Oligopoly banking sectors
▪ Economy that was dominated by real estate and related
services (now 20% of Canadian GDP)
Ireland conclusion: House prices dropped 51%, and non-
performing loans (proxy for defaults) peaked at 37% of ALL loans!
Debt fueled housing bubbles result in crashes and massive
increases in defaults.
1% default rate assumption Analysis range: Year
will prove to be too low. 5 to 15%
House Price Declines
Notable House price declines since 1990
B-20 should reduce prices by 20% Years Decline
Japan 1992-2006 -46
40% decline would bring price-to-income ratio in Switzerland 1990-1999 -44
line with US peak and in line with declines other UK 1990-1996 -57
countries have experienced. Spain 1992-1998 -45
Finland 1990-1993 -71
Bank of Canada overnight rate is 1.25%. There Italy 1993-1998 -40
isn’t much room to cut rates. France 1991-1997 -30
Sweden 1991-1993 -35
Ireland 2007-2012 -54
Spain 2008-2013 -36
Analysis range: Greece 2007-2017 -43
United States 2006-2011 -25
20 to 40% Average -44
Sources: ECB Working Paper No 1071
The Economist house-price indices
Analysis of Potential Losses
Conservative: Ignores mortgages being
Losses for varying default rates and housing
price decreases (CAD$mil) underwritten now, and portfolio insurance
business.
Housing price Default rate (%)
Best case scenario, wipes out excess regulatory
decrease (%) 5 10 15 capital of $400mil.
20 531 1,062 1,593 Default rates anywhere near US peers would
30 976 1,952 2,928 wipe out equity.
40 1,485 2,970 4,455
Total equity plus loss reserves: 4,080
See Annex A for sample calculation
REVENUES ARE BOOKED AGGRESSIVELY
Income Statement Risks
WHAT IF I AM and Canadian
default rates
The income
statement has a
WRONG remain low? lot of risk.
80% or more of premiums are recognized as revenue within first 5 years.

Normalization
Only $2.1bil of unearned premiums on $495bil of insurance unwritten. scenario:
Revenues are dependent on constant stream of new premiums. volumes down 30% from
2016, house prices down
In 2017, transactional premiums were down 14% year-over-year 20%, revenue recognition
(applications were down 20%!). period of 10 years for new
premiums and unearned
Portfolio insurance premiums were down 51% year-over-year. Higher
reserves.
premium rates may mean this change is structural.
Current vs Future Earnings
$CAD million Normalized premiums and extended revenue
Normalized recognition would hurt the income statement
2017 Full Year even without defaults.
Scenario
Revenues 675 249
If revenue recognition extended only 1 year, in
Operating expenses 134 134 normalized scenario, net income would be down
Investment income 198 198 $190mil from 2017 levels.
Interest cost 23 23
Losses on claims in 2017 were 17pts below the 10
Losses on claims 69 69 year average. Normal loss levels would add
Net income (26% tax $115mil to expenses!
479 164
rate)
See Annex B for sample calculations
Other Genworth MI Canada Risks
• Genworth Financial owns 57%, pledged 41% in recently issued term loan.
• Investment portfolio is highly correlated. They have $6.5bil of investments; $0.8bil is in

bonds of Canadian financials and $500mil is in preferred shares ($309mil of which is in
Canadian financials)
• Bad capital allocation. Raising dividend and buying back stock  Lighting needed capital on
fire.
• Homeownership Assistance Program: ~ 56% of potential delinquencies had some type of

intervention; payment changes, payment deferrals, etc. These interventions are not reported
as delinquencies. As a result, the market will be surprised by actual delinquency rates when
they start to rise. There is a YouTube video describing the program (here).
Bull Case and Other Risks to Being Short
Bull case: Risks to short position:
Genworth Canada insures first time homebuyers at price Government intervention. Could roll
points well below average prices. back regulatory changes or BOC could
They cannot insure properties > $1mil, avoiding some of the cut rates. Delaying inevitable.
excesses in Toronto and Vancouver.
Negative carry. Dividend yield of 4.6%,
While LTV’s are high, they claim their borrowers aren’t cost to borrow of 2.5%
risky. Overall insurance volumes may decline, however they
will increase market share (is that a good thing?), and higher
premium rates should help stabilize revenues. Borrow rate cost. Borrow rates for
HCG and EQB spiked dramatically (to
Bull case combined with ROE’s of 13% (unsustainable in my 100%) last year when HCG ran into
opinion), market could price stock at 1.3x book from current issues.
0.9x book (although it historically trades at 0.95x book).
Conclusion
Crash: Soft-landing:
MIC is extremely vulnerable Two paths Balance sheet risks likely MIC’s earnings could
to the bursting of the for housing wipe out the equity. drop 66%
Canadian housing bubble. market: Price target: $2 Price target: $18
Given the risks to the balance sheet

and the income statement, and a
Price target:
stock valuation that doesn’t account
for these risks, I think this is a
Substantially
compelling and asymmetric short. lower…
THANKS
My wife, Bev Bradley

Cam Sterrett
Ben Rabidoux
GLG
The Sohn Conference Foundation
… and everyone who helped me shape this idea
Tim Bergin
tim@onbeyondinvesting.com
@onbeyondinvest
31
Annex A: ‘Actual’ LTV calculations
Outstanding Example:
Mortgages Effective 'Actual Loss
LTV LTV' ($CAD bil) Default rate (D): 15%
($CAD bil) House price decrease (H): 40%
Portfolio Only 100 39% 54%
Transactional by Book Year
2009 and prior 15 37% 52% 0 Loss = (Actual LTV - (1 - H)) ×
2010 6 53% 68% 0.072 outstanding mortgages × D
2011 7 57% 72% 0.126
2012 8 62% 77% 0.204
2013 10 65% 80% 0.3
2014 15 71% 86% 0.585
2015 20 75% 90% 0.9
2016 19 81% 96% 1.026
2017 18 91% 106% 1.242
Total: 218 4.455
Total since 2011 97
Source: Genworth MI Canada
Wgt Average 'Actual LTV’ 90%
Annual Information Form 2017
Annex B: Normalized scenario calculation
A - 2016 Premiums ($bil) $20,000 Inv Yield 0.032
B - Volume Reduction 30% Inv Portfolio 6200
C - Home Price Reduction 20% Yearly Revenues 198.4
D - Average Insurance Rate 3.50%
New Unearned Premiums:
A*(1-B)*(1-C)*D $392
Current Unearned Premium $2,100
Total Unearned Premiums (T) $2,492
Yearly Revs - 10yr recognition

(T ÷ 10) $249
Yearly Revs - 6yr recognition
(T ÷ 6) $415

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Short:

The short is asymmetric

to reapply – rate does not simply roll-over.

Reduces pool of buyers Airbnb use restricted to primary residence

If CMHC itself defaults, government MIC likely insures a weaker

Loan: $300k Insurance

Industry expert estimates that 85% of

Banks have no ‘skin-in-the-game’ and

No wonder almost 50% of Canadian mortgages are insured.

2018: $500k $80.9k

Common uses: HELOC debt is floating rate, and borrower only

▪ buying investment units HELOCs have no amortized repayment, but are

Genworth has significant exposure Volume of 30% in Toronto

“Nearly half of those polled (46 per cent) believe they’re

Similarly, 47 per cent of respondents don’t believe they’ll

Portfolio insurance 100 2 Default rate

‘Actual’ In my analysis I add 15% to

What is more likely?

US Mortgage Insurers 17 to 21% Direct comp to MIC

Overvaluation relative to income

Total equity plus loss reserves: 4,080

See Annex A for sample calculation

80% or more of premiums are recognized as revenue within first 5 years.

See Annex B for sample calculations

• Investment portfolio is highly correlated. They have $6.5bil of investments; $0.8bil is in

• Homeownership Assistance Program: ~ 56% of potential delinquencies had some type of

Given the risks to the balance sheet

My wife, Bev Bradley

… and everyone who helped me shape this idea

Yearly Revs - 10yr recognition

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