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Edited Transcript of GMA.AX earnings conference call or presentation 31-Jul-19 12:01am GMT

Half Year 2019 Genworth Mortgage Insurance Australia Ltd Earnings Call

NORTH SYDNEY Aug 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Genworth Mortgage Insurance Australia Ltd earnings conference call or presentation Wednesday, July 31, 2019 at 12:01:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Georgette Cecelia Nicholas

Genworth Mortgage Insurance Australia Limited - CEO, MD & Director

* Michael Bencsik

Genworth Mortgage Insurance Australia Limited - CFO

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Conference Call Participants

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* Andrew Lyons

Goldman Sachs Group Inc., Research Division - Equity Analyst

* David Poppenbeek

K2 Asset Management Holdings Ltd - Joint CIO & Head of Australian Equities

* Simon Fitzgerald

Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst

* Tim Lawson

Macquarie Research - Division Director of Australian Insurance and Diversified Financial Market Research

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Presentation

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [1]

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Thank you, and good morning. Thank you for joining our CFO, Michael Bencsik, and myself on the call this morning to discuss the 2019 first half results for Genworth Mortgage Insurance Australia.

If we start with Slide 4 of the presentation. The overall market is settling with home prices moderating in Sydney and Melbourne, encouraging buyers back into the market, along with an increase in activity from rate cuts and confidence improving after the federal election. This has resulted in our new insurance written being up 20.7% from $10.3 billion in the first half of 2018 to $12.5 billion in the first half of 2019. We achieved this growth despite an overall smaller residential mortgage market year-on-year by working with our lender customers to identify areas of opportunity and grow our share.

In terms of gross written premium, the large decrease you see relates to the bespoke transaction that we wrote in our Bermuda insurance entity last year. And if you remove that transaction for comparison purposes, our gross written premium was actually up 6.4% in the first half of '19 versus the first half of 2018.

Net earned premium for the half was up 3%, and our loss ratio was 54.1%, both in line with our full year guidance. Statutory net profit after tax of $88.1 million in the first half of 2019 was up from $41.9 million in the first half of last year, reflecting significant unrealized gains of $45.4 million in the first half compared to an unrealized loss of $8.4 million in the first half of 2018 on our investment portfolio. Underlying net profit after tax was down, though, from $50.3 million last year to $43.1 million this year due to the impact of an after-tax realized gain of $9.1 million last year compared to $5.8 million this year, along with an increase in incurred losses from lower cures and aging of delinquencies that's continuing.

From a strategic perspective, we remain focused on product innovation and leveraging data and technology to deliver underwriting and operating efficiencies, and we're seeing the benefit from the launch of our auto decisioning platform and eLMI portal last year, which is enabling us to take data in more efficiently, deliver real-time LMI approval decisions and actively monitor the portfolio through the data that we're obtaining, along with new data sources. The use of new data sources and new technology are delivering tangible financial and operational benefits in terms of programs such as our last policy initiative, which is enabling us to more promptly identify loans that have been discharged or refinanced.

Product innovation and enhancement continues to be a priority as the market and lenders respond to regulatory changes and evolving borrower needs. And we've continued to focus on developing new risk and capital management solutions that complement our traditional single premium LMI product and build on our suite of offerings to our lenders. Our capabilities now includes the single upfront premium LMI product structured in bulk transactions, excess of loss cover, our ability to design bespoke risk management solutions and write them through our Bermuda entity, fixed term or fixed loan-to-value cover and risk share covers such as top cover and quota share.

In addition to developing these product offerings for our lenders, we've made significant progress in enhancing our existing LMI offering to provide greater flexibility and options for borrowers, responding to a need in the market. We've today announced that we're introducing a regular monthly premium LMI offering as an alternative option to our existing upfront single premium offering. The introduction of the regular monthly premium LMI product offers borrowers flexibility in how they pay for LMI while continuing to support a reduction in the deposit they need to purchase a home.

It provides borrowers with the option of not capitalizing the premium into the loan as many do today or coming up with the entire LMI fee upfront. Instead, they can pay the fee in installments over time. This means the greater portion of the loan can be utilized to support the purchase of the property.

We believe the monthly premium may help expand the market where affordability has been a challenge. Importantly, our new monthly premium LMI product provides borrowers with the flexibility to refinance at a later date without the need for a refund of the LMI premium. It also provides our lender customers with the flexibility and option of structuring this offering to enable borrowers to cease paying the LMI premium when their loan achieves a certain LVR. This represents a significant step in enhancing the LMI product offerings, service capabilities and pricing by providing greater choice for both lenders and borrowers.

In addition to our strategic priorities, we've also remained committed to ensuring we're actively managing our capital position. In February, we commenced $100 million on-market share buyback. And as of June 30, 2019, we had acquired 25 million shares for consideration of $63.9 million.

Given the time taken and the level of market liquidity to complete the buyback, the Board has declared the remaining $36.1 million as an unfranked $0.219 per share special dividend today that we announced earlier. The special unfranked dividend is in addition to a fully franked interim ordinary dividend of $0.09 per share declared by the Board. We remain focused on ensuring that we have the optimal capital structure and are continuing to evaluate a range of capital management initiatives to ensure that excess capital is returned to shareholders in the most effective manner.

If we turn now to Slide 5 and the economic and market conditions that we experienced in the first half of 2019. We saw economic growth continue to slow, largely as a result of lower household consumption, weighed down by low wage growth and declining home prices, tight credit condition, slower growth in overall household income and the heightened uncertainty that was leading up to the federal election in May. Unemployment, a key driver of mortgage stress, remained reasonably stable throughout the first half of 2019 at around 5.2%. However, sustained excess capacity in the labor market continued to contribute to low wage growth.

Within this environment, house price moderation continued in all the major capital cities, although at a slower rate. And post the election and following the RBA cash rate cuts, we've seen some green shoots start to emerge with Sydney and Melbourne showing signs that house prices may be starting to stabilize.

From a portfolio delinquency perspective, we saw a slight deterioration in our delinquency rate quarter-over-quarter from 57 basis points at the end of the first quarter to 60 basis points at the end of the second quarter. This is due to the time delinquencies are remaining and aging in the pipeline along with cured being down year-over-year. While new delinquencies, a key indicator of the health of our portfolio, were in line with our expectations and marginally down with the first half of 2018, we continue to observe the extended aging of delinquency portfolio.

The increase in the 10-plus months in arrear delinquency level is indicative of the slower processing of the loss management pipeline by lenders as we started to see in 2018 and continued into 2019. This in turn is slowing cured. We're working closely with our lender customers to clear the backlog and ensure appropriate loss mitigation actions are taken, and we do expect to see some improvement in the overall stock of aged delinquencies during the second half of 2019.

In terms of delinquency trends on a geographic basis, Western Australia and Queensland continue to experience the highest delinquency rates. Across both of these 2 states, year-on-year, our stock of mining delinquencies has declined. However, non-mining delinquencies in regional areas has increased primarily due to aging and slowing cure rates, along with higher unemployment rates relative to the national average.

Overall in the portfolio, Western Australia had some early signs of new delinquencies starting to stabilize when we compare year-over-year. This has been offset though, however, by an increase in aging and new delinquencies in Queensland and New South Wales over the same period. In Queensland, we're seeing new delinquencies across regions in Northern and Central Queensland impacted by unemployment that's elevated. And in New South Wales, while there's some deterioration in certain outlying subregions of Sydney driven by oversupply, borrower affordability constraints, this is off a low base. Within this dynamic environment, we continue to review and adjust our risk appetite, balancing opportunities along with maintaining our risk discipline.

On Slide 6, you can see that the high loan to value market stabilized at around 20% to 22% despite moderating market conditions and tightening credit, which is resulting in an overall contraction of the size of the residential mortgage market in dollar terms. The owner-occupied lending market contracted from the same period last year, and as a result of lenders implementation measures to enhance responsible lending in particular around borrower expenditures, we feel that continuing.

In the investment lending market, the contraction was more marked over the same period, reflecting lender response to regulatory measures designed to ensure stronger serviceability criteria are met in particular around interest-only loans. As lenders continue to focus on identifying their core segments and risk appetite, we're proactively engaging with them to support areas of growth in targeted segments. And this has resulted in our estimated market share being up at approximately 31% of the high loan to value mortgage origination market based on new insurance written for the first half of 2019 compared to 27% at the end of the first half of 2018.

I'll now hand that back -- hand over to Michael Bencsik to provide you with more detail and update on the financials.

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Michael Bencsik, Genworth Mortgage Insurance Australia Limited - CFO [2]

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Thank you, Georgette, and welcome, everyone, on the call. Starting with our first half '19 income statement on Slide 8. First half '19 results were in line with full year '19 guidance. Gross written premium was down 31% this half to $184.1 million. It's largely attributable to the first half '18, which includes a large bespoke transaction written through our Bermudian insurance entity that we called out in our first quarter '19 results. If we are to exclude this transaction, gross written premium or GWP increased 6.4% in first half '19 versus first half '18 through a combination of 2 factors: firstly, the growth in our bulk business; and secondly, the growth in our flow business, reflecting the greater proportion of LMI business written by Genworth lender customers.

Net earned premium was up 3% to $147.6 million, in line with our full year guidance of between minus 5% to plus 5%. This included the release of $4.5 million of unearned premium in first half '19 versus $8.2 million in first half '18 as part of our Lapsed Policy Initiative, which utilizes newly available data to more promptly identify loans discharged or canceled by lender customers. Excluding the contribution of the Lapsed Policy Initiative in both halves, our net earned premium was up 5.9%.

Our investment income, which is earned on technical and shareholders' funds, was up significantly from $44.5 million in first half '18 to $114.9 million in first half '19, comprising during this half $42 million earned from interest and dividend income, $8 million in realized gains, reflecting a reduction in our equity exposures, and $64 million in unrealized gains from our fixed income portfolio due to reducing interest rates. The realized gains, interest and dividend income are included in our underlying net profit after tax or NPAT in both first half '19 and first half '18. Therefore, underlying NPAT of $43.1 million was down 14.3% on first half '18, reflecting 3 factors: the lower realized gains on our investment portfolio this half; secondly, the higher net claims incurred; and thirdly, higher underwriting and acquisition costs. Bringing all this together, statutory net profit after tax for first half '19 was $88.1 million, up 110% on first half '18 of $41.9 million.

Turning to Slide 9. This illustrates the 6-month review since second half 2014 of New Insurance Written by product and the LVR mix of our LMI business. Both charts exclude our excess of loss insurance business written through our Bermudian insurance entity in first half '18 we called out earlier.

During first half '19, our New Insurance Written or NIW increased by 20.7% to $12.5 million, reflecting a change in the mix of our business. Our NIW market share of the high LVR mortgage origination market is approximately 31%, up from 27% in first half 2018. The proportion of under 80% LVR business increased 22% in first half 2019 from 16% in first half 2018, reflecting the increase of $2.4 billion in new bulk portfolio business written in first half '19 compared with $1.1 billion in first half 2018.

Whilst the quantum of our greater than 90% LVR business increased in dollar terms, as a proportion of total NIW, it actually declined from 20% in first half 2018 to 18% in first half 2019. The level of new business we write that has a LVR greater than 90% has 2 major consequences for our business: Firstly, the average flow price -- average price of flow business and our GWP; and secondly, the level of regulatory capital required to support new business.

Turning to Slide 10, provide some further detail on our gross written premium performance during first half 2019. The left-hand side chart shows GWP and average flow price since first half 2015, which indicates that the recent shift to a lower LVR mix has had a downward impact on our overall average price. During first half 2019, our average price dropped to 1.75% from 1.81% in first half 2018. Our response to the shift to a lower LVR mix, particularly in reduction in greater than 90% LVR lending arising from, firstly, lenders' tightening credit policies and risk appetite; secondly, the cost of capital and the current low interest yield environment; and thirdly, less favorable growth outlook for major city property markets. Genworth has revised its LMI premium pricing that effect from 1 November 2019, our first price increase since March 2016, which will be levied on new LMI business written.

The right-hand side chart shows the drivers of change in the level of GWP with a 31% decline in GWP in first half 2019 largely driven by volume, which relates to the excess of loss insurance business written in first half '19 through our Bermudian entity.

The key features of our loss performance is shown on Slide 11. Net claims incurred for first half 2019 was $79.8 million, slightly above the $76.4 million in first half 2018. The number of paid claims in first half 2019 of 615 was down on first half '18 of 666, together with the average paid claim, which reduced from $116,700 in first half 2018 to $94,200 in first half 2019, which is more indicative of the levels of claim settlement with pre-2017 before mining losses started to dominate recent claims experience. This reflects the payment of higher-than-average claims during first half 2018 in those regions that experienced significant house price depreciation, mainly in mining areas, which have moderated in the 12 months to first half 2019. Whilst the claims paid declined 25% to $57.9 million in first 2019, we have taken the opportunity to prudently increase our reserves in both first quarter 2019 of $10.2 million and second quarter 2019 of $11.7 million.

The first quarter 2019 increase related -- in reserves were -- of $10.2 million reflected our decision to increase our factor-based reserves to proactively position the portfolio ahead of any potential impacts that the trend of moderating house price market conditions that may eventuate later this year particularly in Western Australia. In second quarter 2019, the $11.7 million increase in reserves reflects the increased aging of delinquencies and new reported delinquencies in our book.

As a result of these 2 movements in reserves and offset by the reduction in claims paid from $77 million in first half of '18 to $57 million in first half '19, our net claims incurred during the first half 2019 increased by $3 million to $79.8 million compared to first half 2018. As a result, our reported loss ratio was up slightly at 54.1% in first half 2019 compared to 53.3% in first half 2018, which reflects the traditional seasonal uptick in delinquencies historically experienced in the first half of the year and the effect of this additional reserving of $22 million.

Slide 12 highlights the delinquency roll and incurred loss drivers. Whilst delinquency rates increased by 3 basis points from 57 basis points in first quarter '19 to 60 basis points in second quarter 2019, this was largely attributable to the longer duration on book in our delinquency portfolio. This was consistent with the external market data on delinquency trends and also impacted by the benefits flowing through of our Lapsed Policy Initiative. Of note in this half is the number of new delinquencies of 5,515 and the number of paid claims, 615, which are both down in first half 2019 compared to the prior half.

On the cures line, there was a continued softening in cures to 4,154 in first half 2019 compared to 4,289 in first half 2018. This resulted in a number of closing delinquencies in first half 2019 being up 8% to 7,891 on first half 2018.

Finally, on the bottom of the table, we have disclosed the composition of net claims incurred and how we evaluate both our loss development and manage our reserving. The new delinquency reserves in first half 2019 was $77 million compared to $68 million in first half 2018. The cures line represents the release from reserves of those delinquencies that naturally cure in each period of $68 million during first half 2019. Our objective is to ensure that by the time a delinquency transitions to the final stage of mortgagee in possession, we have fully provided for the projected claim as a reserve.

The paid claims gap that you see represents the difference between actual claim payments and the reserves that are released on settlement of that claim. A negative number in prior periods indicates that we have released more reserve relative to the claims that have been paid. What is evident from this slide is that we remain well reserved at the time a delinquency becomes a claim.

Turning to Slide 13. This highlights the continued strength of our balance sheet. The asset side of the balance sheet includes a $3.3 billion investment portfolio, of which more than 83% is held in cash and fixed interest securities with a rating of A- or better. As of 30 June 2019, $84.1 million was invested in Australian equities. And we had diversified our assets with an allocation of $577 million invested in non-AUD income securities. It is our investment portfolio together with our potential reinsurance recoveries that are essentially what is available to our policyholders to meet our ongoing claims obligations, providing us with over 4 billion of claims paying resources. In the context of stress testing, this would still allow us to meet all of our claims obligations equivalent to a 1 in 1,000 year level of probability.

Slide 14 shows the movement in our unearned premium reserve by book year. What is of note in this slide is that we have retained 1.2 billion of unearned premium, which we will gradually earn over time.

Slide 15. Our regulatory capital position remains strong with our PCA coverage ratio increasing to 2.08x capital. The chart that you see on the right highlights the trend of a declining probable maximum loss, which is being driven by the lower LVR business mix being written that I called out earlier and the seasoning of larger back books, which means that the amount of capital we are required to hold is reducing. As of 30 June 2019, the regulatory capital solvency ratio of 2.08x the prescribed capital amount was all in excess of our Board's target range of 1.32 to 1.44x. And I will shortly just talk about our capital initiatives later on.

Some of the notable changes in the composition of our solvency position during the first half 2019 included, firstly, a reduction in the level of common equity Tier 1 capital, which was driven mainly by the commencement of the 100 million share buyback. As of 30 June 2019, we had acquired 25 million worth of shares or $63.9 million of value as part of this initiative; secondly, the payment of the full year 2018 ordinary final franked dividend in March 2019 amounted to $39.3 million; and thirdly, a reduction in the probable maximum loss of $84.7 million, which represents the net of new business capital requirements and the seasoning of back book capital levels under the APRA model.

Taking all this into consideration, if you were to adjust for the payment of the $0.09 per share ordinary franked dividend and the $0.219 per share special dividend announced today, our regulatory capital solvency ratio would be in the vicinity of that 1.94x.

Our capital management philosophy continues to be based on ensuring that we have options available to us and the flexibility to respond to dynamic market conditions. We believe it is prudent to have some flexibility as we assess the outcome of APRA's capital risk weights paper released on the 12th of June 2019 and as we work to identify any emerging strategic opportunities available in the market and particularly customer appetite for excess of loss transactions.

Slide 16 sets out our reinsurance position as at first half 2019. As you'd be aware, our reinsurance program took effect at the beginning of 2019 and follows the successful renewal, which maintains the excess of loss reinsurance levels implemented in 2018. The decision to maintain the same level of reinsurance reflects the reduced probable maximum loss of $1.68 billion as at 30 June 2019 and the desire to maintain an appropriate and flexible level of reinsurance under the APRA guidelines. The reinsurance is provided by a well-diversified panel of over 20 different reinsurers participating across the program with a minimum rating of A-.

Finally, Slide 17 highlights our continuing capital management journey. We remain committed to actively managing our capital position, evidenced by the commencement of an on-market share buyback on the 21st of February 2019. The remaining $36.1 million earmarked under this initiative is to be distributed to shareholders as part of the $0.219 per share unfranked special dividend declared by the Board. The special dividend is in addition to the fully franked interim ordinary dividend of $0.09 per share declared by the Board, taking the total distribution to shareholders to $0.309 per share.

Going forward, we continue to evaluate all capital management options available to us, noting that at the end of Annual General Meeting in May this year, shareholders voted in favor of a resolution approving the possible further on-market share buyback of up to -- 100 million shares over the next 12-month period.

With that, I'll now hand back to Georgette to wrap up.

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [3]

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Thanks, Michael. Before we look at the outlook, I understand that there may have been some technical issues with individuals joining the call at the beginning. And so Michael has covered the financial results and capital in detail, which I covered at the start.

But just as a refresh, from a strategic perspective, again, we continue to remain focused on product innovation and leveraging data and technology to deliver underwriting and operating efficiencies. And we're seeing benefits from the launch of our auto decisioning platform and our eLMI portal that we did last year, which is enabling us to take data in more efficiently and deliver realtime LMI approval decisions while actively managing the portfolio. We're also using new data sources and new technology to deliver tangible financial and operational benefits in terms of programs such as our Lapsed Policy Initiative, which is enabling us to more promptly identify loans that have been discharged or refinanced as well as reducing the level of risk that we're holding and releasing capital.

Product innovation and enhancement continues to be a priority for us as the market and lenders respond to regulatory changes and evolving borrower needs. And we continue to focus on developing new risk and capital management solutions to complement our traditional single premium LMI product and to build out a suite of offerings for our lenders. And our capabilities again now include the singular upfront premium LMI product structured in bulk transactions, excess of loss cover, bespoke risk management solution that we can design and write through our Bermuda entity, fixed term and fixed loan to value cover as well as risk share cover, which can be top cover or quota share.

In addition to developing these products for our lenders, we've also been focused on developing existing LMI offerings to provide greater flexibility and options for borrowers, responding to the need in the market. And today, we've announced that we're introducing a regular monthly premium LMI product offering as an alternative option to our existing upfront single premium offering. And the introduction of that regular monthly premium LMI offers borrowers flexibility in how they pay for their LMI while continuing to support a reduction in the deposit they need to purchase a home.

And it provides those borrowers again with an option of not capitalizing the premium into loan as many do today or coming up with the entire LMI fee upfront. Instead, they can pay the fee in installment over time, and that means a greater portion of the loan can be utilized to purchase the property. We also believe it can help expand the market where affordability has been a challenge.

It also provides borrowers with the flexibility to refinance at a later date with no need for a refunded LMI premium. It also allows our lender customers flexibility and options in how they structure the offering to enable borrowers to either cease paying the LMI premium when their loan achieved a certain LVR or continue. This all represents a significant step in how we're enhancing our LMI product offerings, our service capabilities and pricing by providing greater choice for both lenders and borrowers.

With that, I'll turn to Slide 19 now. And if we look ahead, we expect the economy to receive some foundational support from a number of recently announced activities, including the RBA's cash rate cuts, APRA's changes to serviceability, the federal government's proposed tax cut package and continued infrastructure investment at both the state and federal levels. Added to this, we're also seeing commodity exports throughout the first half of 2019 positively impacted by the economy and supported by a lower exchange rate, and we think that will continue.

Counterbalancing all of that though is continued geopolitical uncertainty and escalating trade tensions, which have the potential to impact global economic growth over the remainder of the year. In light of all of these dynamics though, we do expect that the moderating trend in metropolitan housing markets is going to slow in the second half of the year, particularly in Sydney and Melbourne, with increased stability in home prices heading into the latter part of that year. We do expect Perth to continue to see challenging market conditions, reflecting the ongoing impact of the end of the mining investment boom.

Our 2019 full year guidance though remains unchanged given all of these factors, and we do expect our net earned premium to be in the range of down 5% to up 5% based off of 2018 and the full year loss ratio to be between 45% and 55%.

Overall, our underlying business and customer value proposition remain fundamentally solid, and we continue working on the momentum of our strategic program of work, especially around product innovation and leveraging technology and data. We're also committed to actively evaluating all our capital management options that are available to us to ensure that we're returning the excess capital to shareholders in an effective and timely manner. Our company is well capitalized with a solid balance sheet and net tangible assets of $4.14 per share as of June 30, 2019. And importantly, we have a track record of delivering solid profits and attractive shareholder returns, which we are well placed to continue.

With that, I will open it up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Simon Fitzgerald from Evans & Partners.

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Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [2]

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Just wanted to firstly talk a little bit about the cure rates, understanding the trend from first half '19 to first half '18. We have seen a mild improvement in that first half '19 -- or sorry, first quarter '19 to second quarter '19. Just wanted to get your sense of whether you're expecting further improvements in cure rates over the rest of the year or is this just a seasonal effect.

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [3]

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Yes, I'll start and then Michael can add. I think we're working proactively with our lenders to address some of the slowdown that we've seen in the loss mitigation process in particular around hardships and around borrower sales and moving things to mortgagee in possession. Again, I think as we've talked about previously, some of that has been related to cutting off the Royal Commission and some of the activity of re-reviewing things in much greater detail, asking for some more information. But we're starting to see, I think, some movement in that and do expect that we'll see some improvement in the back half of 2019.

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Michael Bencsik, Genworth Mortgage Insurance Australia Limited - CFO [4]

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Yes. A lot of the increase, Simon, is in the 10-plus months delinquency level, which is indicative of the slower processing that Georgette has referred to on our loss management pipeline. But I guess with a further reduction in interest rates of [20 -- the 225] basis points cuts, we do expect to see a positive effect on our cures flowing through. But it really is in relation to just the slower processing time, a longer time in our books of our overall delinquencies.

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Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [5]

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Sure. Okay. Second question is just a little about the LVR trends. If we look on Page 34, we can now see that vintages 2017, '18 and '19 all have effective LVRs higher than the point of origination. Just wanting to know -- get a little bit of a sense of whether you're getting concerned. I mean even 2016 looks borderline and I imagine 2019 wouldn't see a huge move to see that negative equity. So just wondering your thoughts on that.

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [6]

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Yes. No, I think it's something we certainly watch. And that's part of what we consider as we look at our loss mitigation strategy and what comes into the pipeline. I guess for us, that's always a potential And so for us, it's about the underwriting and the quality of the underwriting in those portfolio years. I think again, since 2009, when a lot of changes were made. Certainly 2014, there was another kind of step-up around serviceability, has all strengthened the underwriting quality of those books. And we don't really see again significant development in 2015 forward. I think where we see development even at 2012 to 2014 book year is around mining, not necessarily significantly outside of that. So again, something we're watching and certainly thoughtful about as we look at our loss mitigation strategies. But again, it comes back to the quality of the underwrite.

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Michael Bencsik, Genworth Mortgage Insurance Australia Limited - CFO [7]

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And Simon, to talk a bit about negative equity, I mean, when we look at our sort of 30 June overall book, negative equity is in the region of around 5% based on sort of current models. And we're seeing a very small percentage, but most of that is in -- highest levels in Western Australia and Northern Territory. But nothing of overly concern at the moment.

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Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [8]

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Okay. That's helpful. And just 2 more questions here. Just on the LMI product which will be paid on a monthly basis, can you talk to us about how we might need to think about that from a written premium or earned premium perspective or an accounting perspective?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [9]

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Yes. Certainly, as time goes on, Simon, and it gets more adoption and traction in the market, we'll talk broader about that. But I think you can compare it to similar product in the U.S. where again, the monthly premium comes in and gets earned within a short period of time. So whether that's on a monthly or annual basis, it will be reflected there. It's really about then when did the loan cancel. And I think that's one of the things -- as the product develops, how lenders look at that as well as the borrowers. In the U.S., they cancel that at certain LVR limits. We certainly could adjust that based on the market. And so again, it's really about looking at the persistency or cancellation rate of the loan versus where we have now the upfront premium.

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Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [10]

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Okay. And just a final question. You've seen in the media a lot about the sort of Sydney apartments sort of entered into some really difficult issues around the construction. I was just wondering if you had any exposure to those or indeed if you're sort of evaluating apartment lending in any different line.

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [11]

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Yes. So certainly, we have loans that may be in some of those units, I would say, in the units that have been noted, very small. What we're thinking about is, right, what other unit buildings might have exposure and so trying to get some insight around that. Certainly, we don't necessarily pay for physical damage to the property but certainly can appreciate that there will be a flow on impact as people are impacted and cannot pay the mortgage. So again, we're assessing that, but it's probably pretty minimal for us given our history with limiting unit exposure and the number of units within an actual building. So again, we have some pretty strict policy guidelines around that.

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Operator [12]

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(Operator Instructions) Your next question comes from Andrew Lyons from Goldman Sachs.

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Andrew Lyons, Goldman Sachs Group Inc., Research Division - Equity Analyst [13]

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Georgette, just firstly, you've attempted to accelerate your capital management agenda this half. But even post the payment of the special and ordinary dividend, it was noted that your PCA will still be at 1.94x. At that level in the past, you have announced further capital management. So I was just hoping you could provide a bit more data as to why nothing further is being announced today, particularly given you already have the shareholder approval for the additional 100 million of shares. I'll have a subsequent question after that.

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [14]

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Yes, thanks, Andrew. I think again, as we've looked at capital, there's a number of approvals that we have to go through. And that's part of the process. Some of that is, you can imagine, based off of results. And first half results is a part of that. So that is part of it. I think we also, to your point, have looked at many options in the past, including the capital return. And so I think we're really assessing all of our available options, including how we think about our reinsurance structure and our Tier 2. So all of that is kind of going into the mix. So again, we've announced a special dividend to close out, the buyback that we still had in process that hasn't completed. And so again, as we come to the third quarter and year-end, we'll certainly have more assessment of what we're doing there.

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Andrew Lyons, Goldman Sachs Group Inc., Research Division - Equity Analyst [15]

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Just a subsequent question, just around the ROE. If I look at your ROE adjusted towards the top end of your target range at 1.44x, it's still a little under 9%. I just want to understand, with the raft of new products that you've released over the past 12 to 18 months, what does the ROE profile of these new products look like? Do you see them as accretive to group ROE at sort of optimized capital levels? And then secondly, you spoke about the impact on both premium earned and the capital requirement of the sub-90% LVR mix. Can you just talk about the ROE? What does the ROE of the sub-90% LVR product look like versus the greater than 90% LVR?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [16]

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Yes, thanks, Andrew. I think again, as we look at the new products, they certainly have to meet our ROE thresholds of meeting our cost of capital. And as we've talked about in the past, that we're still targeting kind of that low to mid-teen ROE, and that's still certainly something that we are working to achieve. And so as we look at these new structures, new products, that's the measure. Some of it is also -- some of these products will allow us to think differently about our expense structure. And as we've noted in the past, we've been working through that and kind of making movement changes the last couple of years. And that continues to be something that we look at and think about.

So again, we are targeting that low to mid-teen ROE. I think as we look at traction with these products, right, we're hopeful that, that will add to the net income, right, profile. And certainly, that will also help ROE, while we continue look at our capital optimization, which again, as we talked about earlier, includes all of those assessments around the structure of capital with reinsurance debt and then hard capital.

So I think one of the things we are trying to do is there has been history in the cross-subsidization within the business in the rate card and certainly of that above 90 having higher threshold. Part of that is the capital level that's required to be held. And so again, we're reassessing that and certainly are making some adjustments to rebalance that rate card to reduce that subsidization. I think that if you look at the below 90, it's still meeting our threshold of that cost of capital, and so we are still trying to achieve again that low to mid-teen ROE there. Some of it is around the pressure with expenses, as you can imagine as you look at that. But we certainly are targeting that.

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Operator [17]

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Your next question comes from David Poppenbeek from K2 Asset Management.

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David Poppenbeek, K2 Asset Management Holdings Ltd - Joint CIO & Head of Australian Equities [18]

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Just interested in your view, Georgette, about the average paid claims. I noticed that from the time that you started to today, the average paid claims going from sort of 65,000 up to 94,000, the cure rate's fallen from 45% to 30% and the number of arrears over 10 months has kind of doubled. But the PML stand 35%. I'm just wondering whether you think there's a chance that the incoming CEO for Genworth is going to have to deal with the change of backdrop like what you had to deal with in regard to revenue recognition curves. Do you think there's a chance that the calculation imports for PML is potentially different than current experience given the build-up of aging?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [19]

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Yes, David, thanks for your question. I think if you look at the history of the business, what I came in and what was happening with home prices, especially in Sydney and Melbourne, and wherever delinquency population was and where it's developed to, I think what you would see is we've got a lot of cures from Sydney and Melbourne in kind of 2015 and '16 as home prices went up. We saw unemployment creep up in mining in particular in Western Australia and Queensland, probably back half of 2016 into '17, which created delinquencies in those areas, in particular around mining, which have also experienced significant home price decline.

And so as we've looked at the paid claims that we're paying over the last 2 years, that certainly has been what's been driving that increase in the paid claim from historical kind of average of probably 65,000 to 75,000 right up to the 100,000 level. So it's really mining. I think as we've talked about, we certainly got ahead of the mining from a reserving perspective in the second half of 2016 and into '17 and certainly has been monitoring that.

In a way you can tell whether that's holding up is the paid claims gap that's on the incurred loss schedule in the presentation. That's one of the things that we've added on page-- Slide 12. You can see again the rolling delinquency rate as well as the rolling reserving as net claims incurred. So you can see there that the reserves are holding up at the paid claims. Certainly, we continue to evaluate that, and if we thought we needed to make an adjustment, we certainly would've done that in this quarter. It is a pretty robust review process on a quarterly basis that we do around reserving, and that certainly goes all the way up through the Board and -- for approval.

As we think about the earnings curve, we did review that last year. We reviewed it again coming off of first quarter and even into this quarter. And so again, feel comfortable that again, the assumptions in that curve and why we extended it are holding up. But it's something we certainly keep monitoring. And again, it's an estimate. If circumstances change, certainly we'll review that as we come into the back half of the year also. And it's not just waiting for, again, a change in the CEO.

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David Poppenbeek, K2 Asset Management Holdings Ltd - Joint CIO & Head of Australian Equities [20]

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Okay. Just another point in regards to the paid claims. Is the logic of the longer mortgages in arrears -- obviously, there's a build-up of accrued interest. Is that becoming, I suppose, a more, larger influence in the potential average paid claim over the foreseeable future? Like is it going to -- the longer these loans stay in arrear, obviously the accrued interest builds. Could it be that there's sort of 7,000 to 10,000 added level? Like instead of the paid claims running off as the economy improves that, that accrued interest build-up means that average paid claims stay higher for longer like you said?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [21]

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Yes. No, so certainly, accrued interest is part of what we cover. But we do have a cap in the master policy. So we pay accrued interest up to 500 days. Also, as we look at the delinquencies, there has to be an active management of the delinquency as it goes through the process, which certainly -- as we look at that, if for some reason, loans were not being moved through that process and we felt like interest is accruing, we could adjudicate that claim. But certainly, as things age, they get in -- they are taking 10 to 12 months longer than historically they have, certainly there will be an interest piece of that. But we don't think it's significant given some of those master policy caps that we have as well as our loss mitigation process. So it's one of the things that we certainly try to drive as a benefit to the borrower to make sure that the costs that are being accrued and put on that loan, right, are reasonable and as less burdensome to the borrower because, again, of the borrower -- recourse nature of the market.

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Operator [22]

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Your next question comes from Tim Lawson from Macquarie Group.

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Tim Lawson, Macquarie Research - Division Director of Australian Insurance and Diversified Financial Market Research [23]

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Just firstly on the capital side, just so I'm clear, are we saying now that the special type dividend is the preferred way of returning capital given the liquidity issues you've had with the buyback even though you've got that 100 million share buyback effectively approved through the AGM?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [24]

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No, thanks, Tim. No, I don't think it's our preferred method. I think what we're trying to do is balance all of our options with also the timing of returns. So again, I think to your point, we started that buyback before the AGM and got additional approval and so want to be able to potentially utilize that. And so felt, again, given where we were with the buyback, the liquidity that was available in the market, that we -- that the Board declared a special unfranked dividend to get that buyback completed.

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Michael Bencsik, Genworth Mortgage Insurance Australia Limited - CFO [25]

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So liquidity, Tim, in the market changed a bit and has tightened as we're moved into an ASX 300 stock, and also, the repositioning of some of our investor base on our sort of share register has also moved as they change the risks. So I think there were still [a lot] attracted to the yield of our stock. We've been trading at 0.6x book at the moment. So there is an element of sort of feedback we've got from our investors and shareholders that prefer a buyback, but there are some which will prefer a type of dividend, whether it's franked or unfranked. So it is around sort of maintaining that flexibility, and as Georgette called out on, we're also looking at balancing how much capital do we really need to -- we've got the sub-debt and we've also got the reinsurance. But also, we've got a strategic program of work that we wish to invest in the business. So there is a confluence of factors which we have to maintain that flexibility.

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Tim Lawson, Macquarie Research - Division Director of Australian Insurance and Diversified Financial Market Research [26]

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And just a question around claims. You talk about sort of working with the lenders to try and clear the sort of the backlog, whether that specifically should be of claims in terms of the pipeline that goes through the bank. Can you talk about any potential issues around the paid claims gap with those claims? As they've got older, I imagine you've taken more reserving. But they're not necessarily deteriorating from an underlying point of view, deteriorating from time point of view? And then also just a related question in terms of the cures slide, the loss development slide where the number of volume of cures has declined, the dollar value appears to be going in the reverse side. Can you just talk me through that?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [27]

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Yes. So I think if you -- I'll start, Tim, and Michael can jump in. I think if we look at the loss mitigation, when we talk about them aging, again, a lot of them are sitting in the 10-plus. And if you look at Slide 39, you can kind of see the breakdown and where they are. So again, you see kind of our mix of -- we're running at about somewhere between 10% and 12%, right? That's now down about 8%. So again, it's not been hugely significant. Where you've seen the movement, again, it's at 10-plus, where it was running at about 20%, right? It's now at about 23%. So I guess when we say there's aging, that's where we're talking. So again, it takes probably 18 to 24 months to move from a delinquency to a claim. We're not seeing that necessarily extend out significantly at this point, but that's what we're watching, right?

And so what we're seeing is we were seeing things probably closer to that 18-month development period get cleared and now it's taking a little bit longer. So we think we're moving closer to that kind of 24 months given some of the things that have happened. So that's -- as we think about the paid claims, we certainly know what delinquencies they are. As you can imagine, we do look at the reserving. Once we get in the 10-plus in arrears, we start looking at it on a loan-by-loan basis.

So we can do an automated valuation and have an idea of where the severity is on that property as well as, again, we're getting more and more information on where the borrower stands and whether we think there will be a cure or not related to the borrower. So again, we're able to make a much better prediction when it's in that 10-plus-month bucket.

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Tim Lawson, Macquarie Research - Division Director of Australian Insurance and Diversified Financial Market Research [28]

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Is the average severity of the arrears in that 10-month-plus bucket getting worse? Or is it pretty stable versus the lines a year or so ago?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [29]

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Yes, it's pretty stable. Yes, again, a lot of it is mining related, right, or in kind of the regions outside of Perth that we talked about kind of the knock-on effect. So that's where we see again kind of a slowing as well as, again, some of the areas where we've seen in New South Wales where we've been slowing around some of the relooking at hardships and so forth. And we've talked in the past about payment plans for borrowers. That's some of the other slowing that we see in those earlier buckets. So again, I would say overall, the severity has been stable. It's not significantly changed. It's more about what we think might happen from a frequency perspective.

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Tim Lawson, Macquarie Research - Division Director of Australian Insurance and Diversified Financial Market Research [30]

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And just the cures number reducing but the cures dollar release, if I'm reading that correctly, increasing?

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [31]

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Yes. So a lot of it will be about the mix of delinquencies and where those cures are coming from. So if we think about if they come from higher-valued loans or areas like Sydney or Melbourne versus Western Australia or Queensland, right, that would be the dynamic that would change the dollar amount.

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Tim Lawson, Macquarie Research - Division Director of Australian Insurance and Diversified Financial Market Research [32]

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Okay. So the cures are coming from previously higher reserves?

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Michael Bencsik, Genworth Mortgage Insurance Australia Limited - CFO [33]

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Yes, that's correct, yes.

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [34]

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That's right.

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Operator [35]

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There are no further questions at this time. I would like to apologize for the technical difficulties we had earlier. And I'll hand back to Ms. Nicholas for closing remarks.

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Georgette Cecelia Nicholas, Genworth Mortgage Insurance Australia Limited - CEO, MD & Director [36]

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Thank you for joining us for our first half 2019 results call for Genworth Mortgage Insurance Australia. We appreciate your interest and look forward to seeing you as we get out on the road. Thank you for joining us.