Income Report / Income Note: 3 income stocks to benefit from the change to lending rules (IFL, GMA, MOC, AFG)

The market is getting hit hard today to end the month and the quarter with the debate between Trump & Biden dominating the news cycle. I watched a small section however a lot on the plate today so not enough time to consume much – we’ll touch on it probably tomorrow morning however suffice to say, given the about turn in US Futures from +0.3% to down -0.6% Biden got the upper hand.

Locally, selling is broad based with 185 companies in the ASX 200 trading down, one bright spot is Corporate travel (CTD) which has rallied after announcing a highly earnings accretive acquisition while also completing a capital raise – the stock’s up ~11%.  

Overall, the ASX 200 is currently trading down -97pts / -1.63% to 5854.

ASX 200 Chart

The Income Portfolio was up strongly this week, adding 2.02% across the 5 sessions helped by a robust equity market. Strong moves to the upside were seen by NAB (+8.65%), SYD (+7.96%) and ABP (+7.27%) while the main drag was IGL (-8.28%). There were no dividends during the week. The portfolio is up +4.41% FY21 to date with the benchmark (RBA + 4%) sitting at 1.05%.

Last week we focussed on IOOF (IFL), the very unloved wealth / funds management company which has recently bought MLC and raised ~$1bn in fresh equity. This week we’ll expand on that looking and 3 more (until recently) unloved income opportunities, but before we do, we concluded last week that the selling pressure looked to be drying up and the stock was approaching an accumulation level. While one week does not make a summer, the stock is showing tentative signs of support, so why didn’t we buy it?

We have Perpetual in the portfolio and were looking for a switch on valuation grounds, however PPT has also gained some support as stocks rebounded from the bottom of their trading range.

IFL is on our radar, however MM is looking for a switch from PPT into IFL at the opportune time.

IOOF (IFL) Weekly Chart

I was speaking with a client yesterday who was wanting to help his daughter buy a house. He has a number of businesses that bank with CBA, a farm valued at ~$4m with 400K of outstanding debt attached to it. He’s been a customer with them for 30+ years however the complexity and detail required to increase that loan modestly  has caused him to allocate funds from elsewhere. From my own perspective, each year I rejig my mortgages to increase available liquidity, important when running a business and I’d rather be looking at available capital than for it. In the last year or so, I’ve experienced a similar sort of frustration and I doubt Peter and I are alone. The cost and availability of credit are two very important factors that underpin asset prices, and while the cost of credit is clearly no hurdle, availability has been.  

The move last week by the Government to remove the existing responsible lending standards works to improve the availability of credit. Many ‘sensationalists’ in the media are highly critical of the approach talking about loose credit and debt binges, however in MM’s view, less regulation is one obvious input to get the economy back up and firing.

Firstly, the removal of the existing responsible lending rules has the following effects: 

1.       Makes credit decisions quicker because less verification of the borrower’s details is required by the lender;

2.       Makes credit decisions cheaper because less resources need to be allocated to each loan application;

3.       Reduces compliance risk because the law placing the responsibility on the lender is removed;

4.       Increase credit growth in the short term to the increased speed of loan approvals; and

5.       Possibly increases credit growth in the long term because borrowers may receive credit who would previously have found their loan applications rejected.

The combination of these factors is positive for banks and other companies with exposure to growth in mortgages, we cover 3 of these below.

3 income stocks to benefit from a change to lending rules

1 Genworth (GMA) $1.59

We’ve held the mortgage insurer before in the MM Income Portfolio having sold it back in January of this year at $3.69, since them it has been one way traffic with the share price hitting a $1.22 low in March before closing yesterday at $1.59. In July they suspended their 1H20 dividend while reporting a decent loss. As we’ve often suggested regarding GMA, this is a complicated business with many economic factors that play into their performance. The easy conclusion around GMA is, ‘it’s all too hard’ however therein lies the potential opportunity in MM’s view. Earnings in this business ebb and flow so the best metrics are price to book and capital position. Price to book looks at price versus the value of their asset base while their capital position will be a major factor when thinking about dividends.

GMA is trading at 0.5x price to book = cheapest it’s been while the capital position is strong, and above the boards target range. They did recently suspend their first half dividend as a prudent measure in case economic conditions deteriorated which is clearly a plausible scenario, however news last week around the easing of lending restrictions is a positive for loan volumes, particularly those with higher loan to valuation levels that require lenders mortgage insurance (LMI).

GMA is a deep value (future) income opportunity back on the MM radar

Genworth (GMA) Chart

2 Mortgage Choice (MOC) $1.09

MOC is a mortgage broking business that runs a franchise model (much like CBA owned Aussie Home loans) and is a clear beneficiary of reduced lending regulation and the likely increase in volumes. This positive news snaps a period of major headwinds (royal commission, anaemic lending volumes, poor business management, leadership changes etc) with the stock in an entrenched downtrend since 2013 – the obvious question now being, is this a game changer?

On just 12x earnings and now expected to yield 7%, its clearly on the cheap side of a relatively expensive market. Earnings tailwinds now include reduced regulation meaning more mortgages will be approved, record low interest rates making borrowing cheap and reports show we’re about enter a strong period of borrowing demand with an increase in the 35-54 year old age bracket over the coming decade,  which generally drives mortgage growth i.e. baby boomers who often have no mortgage selling to up sizers who increase borrowings to buy.

The issue though remains the runoff in their book which creates a trend of flat / declining earnings. In other words, more mortgages are winding up than are being created. If they can address this and begin to growth earnings, their P/E will also re-rate higher.  

MM is now bullish MOC  

Mortgage Choice (MOC) Chart

3 Australian Finance Group (AFG) $2.10

AFG is a slightly different company insofar as it does origination of loans while it also has a financing capability where it either white labels or securitises mortgage products,  meaning it becomes akin to a traditional broker and lender in one, therefore attracting better margins. The key to this business is their ability to drive the pickup in loan volumes into their own branded products which is made easier through the revised best interest duty.

AFG trade on just 11x while yielding 6% fully franked

MM is bullish AFG

Australian Finance Group (AFG) Chart

Conclusion

The change to lending rules is a positive to loan growth

Mortgage brokers are the most direct way to play that change in trend

We are bullish MOC & AFG, while keeping GMA on the radar

Disclosure

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