Description

Company Description 

Enact Holdings (“ACT”) is a private mortgage insurer that was recently spun-off from Genworth Financial (“GNW”) who continues to own 81.6%.

ACT provides credit protection to mortgage lenders and investors, covering a portion of the unpaid principal balance of mortgage loans where the loan amount exceeds 80% of the value of the home. This facilitates the sale of mortgages to the secondary market, including to Fannie Mae and Freddie Mac and private investors, and protects the balance sheets of mortgage lenders that retain mortgages in their portfolios. 

ACT has a large and diverse customer base across the mortgage origination market, including with national banks, non-bank mortgage lenders, local mortgage bankers, community banks and credit unions. It provides new insurance coverage to approximately 1,800 customers, including 19 of the top 20 mortgage lenders.

ACT business has performed well over the last few years growing book value from $3.3bn at the end of 2018 to $4.2bn at Q3 2021 (after paying out a total of $737mm of dividends to GNW).

ACT has been consistently achieving double digit ROEs, including in the 2020 COVID affected year. Going forward, management guides to underwriting business in the low to mid-teens ROE.

Competitive dynamics appear relatively stable, with only 6 main players participating in the industry. ACT is the 3rd largest player as of Q2 2021 with a 16.9% market share

Opportunity

ACT appears to be an attractive opportunity as its business fundamentals and double-digit ROE are not reflected in its valuation with the stock trading at 0.84X book value and 6-7x Forward P/E.

A base case return to 1.0x P/BV or 9.0x P/E by end of 2024 would provide a 3-year IRR of 13-18%.

A best-case return to the 10yr median historical P/BV for MTG and RDN (2 of ACT main competitors) of 1.2x or 10P/E would provide a 3-year IRR of 28%.

Investor Concerns

The valuation gap can be traced back to investor concern related mainly to: i) GNW ownership overhang; ii) Net Premium Rates decreasing; iii) decrease in credit quality.

GNW ownership overhang from its 81.6% ownership stake will potentially impact short term valuations, but the concern appears overstated as GNW has significantly de-leveraged its balance sheet to $1.3bn of debt and it has no immediate necessity to accelerate the monetization of its ACT stake. The main short-term impact will be a preference for ACT cash flow capital allocation to be in the form of dividends as per the recent $200mm or $1.23 per share pay-out (6.0% yield based on current market price)

Net Premium Rates decreasing are a real headwind as the low interest rate environment has impacted persistency (50-60% vs 70-80% in the 2018/2019 period) which led to higher priced legacy insurance to be replaced. This trend should be mitigated by the expected increased interest rate environment and the continued rational pricing model demonstrated by the 6 industry participants during the last decade. In addition, increased interest rates would be a positive for ACTs short term duration $5.4bn investment portfolio (1% increase providing ~$54mm additional pre-tax income)

Credit quality is currently very sound, with delinquencies significantly reduced and favorable dynamics linked to the real estate price appreciation (18.5% YoY) which should reduce outstanding LTVs and loss severity. 

Summary

ACT should provide significant downside protection at 0.84X BV and provide a relevant 6% dividend yield, while we wait for the market to appreciate the mortgage insurance business in a rising interest rate environment and re-rate its multiples to the historical median for the industry. This should allow for attractive mid-teens to twenties IRR over the time period.

Risks

• Industry participants pricing irrationally reducing ROE

• GNW overhang putting floor to market price

• Unexpected economic distress pressuring real estate prices and / or consumer balance sheets

Catalyst

Catalysts

• Removal of GNW ownership overhang

• Continued increasing capital return in the form of dividends / share buybacks