Enact Holdings (ACT) & Genworth Financial (GNW)

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February 15, 2022

We own positions in both Enact Holdings and its parent company, Genworth Financial. Enact is one of six mortgage insurance companies. Mortgage insurance is purchased by borrowers to protect lenders if the borrower defaults on their mortgage. The government mortgage agencies (“GSEs”) require mortgage insurance when the borrower has a down payment of less than 20% of the home’s purchase price. Usually, first-time homeowners are the largest users of mortgage insurance since they often have the most difficult time accumulating enough savings for a 20% down payment. We believe the demand for mortgage insurance will be strong, but the mortgage insurance companies’ stocks are priced as though future earnings will not grow.

Here are our investment theses on Enact Holdings and Genworth Financial:

Enact Holdings

1. Ignored stock – Enact’s stock is ignored because of its low float. Enact held an initial public offering in September 2021. Genworth retained ownership of 81.6% of Enact’s shares. 9% was sold in a private placement to another money manager, so only 10% of Enact’s shares are free to trade by public investors. This prevents larger investors from taking a significant position in Enact.
2. Low valuation – Enact trades for 85% of tangible book value and 6x earnings. It is the least expensive stock of the publicly traded mortgage insurers, and we believe the entire group is cheap. The valuations are especially attractive given there are likely very few losses in their existing portfolios, and mortgage insurers have used strong underwriting criteria since the Great Financial Crisis (“GFC”).
3. Strong housing market – The Millennial Generation is in their peak home-buying years. We believe insurance volume will be robust for all mortgage insurers. Strong housing prices mean that the existing portfolios of the mortgage insurers will experience low losses.
4. Dividends in the near future – We expect Enact to begin paying dividends to shareholders in late 2022. Because Enact generates more capital than it needs for growth, we believe Enact’s board will set the dividend payout rate at 40% of earnings. This would translate to a stock yield of about 6%, which we think will be attractive to potential shareholders.
5. Parent oversight – Genworth owns 81.6% of Enact stock, and we believe there are benefits from Genworth’s oversight of Enact. As the only cash-flowing asset owned by Genworth, we think Genworth will encourage Enact to pay dividends to shareholders. Although we don’t expect Enact management to make any poor acquisitions, we believe Genworth serves as an effective blocker of any poor capital management decisions. We acknowledge that Genworth limited their control over Enact by reducing the number of Board seats they control, but we think Enact’s board is aware of Genworth’s preferences for significant capital return through dividends.
6. Industry growth – The mortgage insurance industry is growing between 6-10% annually. With rising home prices, borrowers will have an even tougher time accumulating money for a down payment, so they will turn to mortgage insurance. Also, the Millennial generation is at its peak years for buying a first home. First-time home buyers are the largest users of mortgage insurance. We believe the mortgage insurance industry will continue to enjoy strong volume growth in the coming years.

Other stock market investors see risks to Enact’s shares:

1. Price competition – Some investors point to the potential price competition among mortgage insurance companies. Mortgage lenders choose the mortgage insurer for a borrower. The mortgage insurance industry is very price competitive. Recently, mortgage insurers have been disciplined in their pricing, and we believe investors will react favorably as pricing shows more stabilization this year.
2. Risk to home price declines – We believe many investors still have fresh visions of home price declines from 2006 to 2010 in their minds. Although home prices have increased substantially, we think the current housing market is fundamentally stronger than 15 years ago.

Our two main reasons for this constructive view of the housing market are as follows:

1) Almost 100% of current mortgages were underwritten with fully documented loans.

2) We have a shortage of homes because we did not build enough houses in the 12 years since the Great Financial Crisis. We don’t believe home prices are at-risk in the near-term. We hold this view despite the potential for higher interest rates.

3. Potential spin-off from Genworth – Many investors are concerned about pressure on Enact’s share price if Genworth distributes its Enact shares to Genworth shareholders. We are not concerned about this possibility because Genworth needs to retain its Enact shares to get the tax-sharing payments from Enact. Genworth has accumulated tax losses and files a consolidated tax return with Enact, so when Enact accrues for taxes and sends that money to Genworth, Genworth can keep the cash because of its past losses.

Genworth Financial

We also own shares of Enact’s parent company Genworth Financial. We think Genworth is more attractive than Enact. Here is our investment thesis on Genworth:

1. Leveraged return on Enact – Genworth’s main asset is the 132 million shares of Enact it still holds. Genworth also has about $1 billion of net debt at its holding company, so it is a leveraged version of Enact. If Enact stock increases in value, Genworth should increase a greater percentage due to the leverage at Genworth’s holding company.

2. Two other assets held – Genworth has two other assets that we believe are not reflected in Genworth’s stock price. Currently, Genworth trades for approximately the value of its stake in Enact less its net debt. The two other assets Genworth owns are:

4. Tax-sharing arrangement – Genworth has a tax-sharing arrangement with its subsidiaries. Since Genworth has past losses, it does not pay federal income taxes. Regulators allow Genworth’s subsidiaries to send tax payments to the holding company for liabilities created by the subsidiaries’ current income. However, the holding company can retain these cash tax payments because it has the tax shield from past losses. This tax-sharing arrangement allows Genworth to get cash out of the subsidiaries without asking regulators to allow dividend payments. In 2021, Genworth received $375 million in tax-sharing payments from its subsidiaries. We conservatively estimate Genworth could receive $200 million per year for the next five years. This amount would equal $2 per share, which is significant considering Genworth’s stock is only priced at $4.

5. Life insurance subsidiary – Genworth also owns a life insurance subsidiary. The life insurance subsidiary is a large company on its own, but we assign zero value to this subsidiary because of potential losses in its long-term care insurance business. However, we observe that Genworth’s management team has done a very good job raising rates on its long-term care policies to counteract increasing policy costs. There is some possibility that 10 years from now, management’s actions could salvage some value from this subsidiary. If this subsidiary has any value, it could be so large that it would be meaningful to the stock price. For example, if the subsidiary is eventually worth half of its current $11 billion of book value (or $5.5 billion) then this subsidiary could be worth almost $11 per share. This potential scenario is far down the road, so currently we conservatively assign zero value to this asset in our valuation of Genworth.

3. Share repurchases on the horizon – We expect Genworth to begin repurchasing its shares during 2022. Genworth has paid down its holding company debt to its target level of $1 billion. As Genworth receives cash at its holding company from its tax-sharing arrangements with its subsidiaries and dividends from Enact, we believe Genworth will announce its intention to repurchase shares as early as the Q1 earnings announcement in early May. Since we believe Genworth’s shares are trading below intrinsic value due to the attractive valuation of Enact and Genworth’s other two assets, we believe these potential share repurchases will create additional value.

4. Optionality with Enact stake – While most investors think Genworth will spin-off its stake in Enact, we think it is more likely that Genworth will buy-in the Enact shares. Genworth’s financial position has improved rapidly in the last year. As Genworth uses its cash flow from the tax-sharing arrangements and dividends from Enact to repurchase its shares, we think a possible scenario is for Genworth’s shares to outperform Enact’s. Right now, we believe Genworth is cheap relative to Enact, but if this were to flip, where Genworth was relatively more expensive than Enact, we think it will make sense for Genworth to buy-in the Enact shares it sold in September 2021.

We believe Enact and Genworth are both interesting stocks at their current valuations. We believe Genworth has a higher upside due to being a leveraged version of Enact, and because of its other two assets to which the market is not assigning any value.

Disclaimer: The discussion of any security is meant solely as an illustration of our investment and thought process and should NOT be considered as a recommendation or suggestion to buy or sell any securities. Before you make any investment, do your own research and talk to your own financial adviser. Information in this report is received from external sources. Therefore, we can make no guarantee as to the completeness or accuracy of the information provided.