Genworth Financial, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; filed August 1, 2018. Genworth operates U.S., Canadian and Australian mortgage insurance businesses, U.S. life insurance operations, and a runoff segment. Unless indicated otherwise, amounts are in U.S. dollars.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $2.159bn | $2.223bn | $4.274bn | $4.394bn |
| Net investment income | $828m | $801m | $1.632bn | $1.591bn |
| Net investment gains (losses) | $(14)m | $101m | $(45)m | $135m |
| Income before tax | $360m | $401m | $588m | $733m |
| Net income attributable to Genworth common stockholders | $190m | $202m | $302m | $357m |
| Diluted EPS | $0.38 | $0.40 | $0.60 | $0.71 |
| Adjusted operating income attributable to common stockholders | $200m | $151m | $325m | $294m |
Q2 revenue declined 3% and six-month revenue declined 3%, largely because investment gains in 2017 became losses in 2018. Six-month premiums rose 1% and net investment income rose 3%. The effective tax rate was 29.6% for the first half, down from 33.6%, primarily reflecting the U.S. federal tax rate reduction under the Tax Cuts and Jobs Act (TCJA). The filing reports positive earnings but does not provide a consolidated operating margin.
- Segment adjusted operating income, first half: U.S. Mortgage Insurance $248m (prior year $164m); Canada Mortgage Insurance $95m ($77m); Australia Mortgage Insurance $41m ($25m); U.S. Life Insurance $52m ($92m); Runoff $23m ($25m); and Corporate and Other $(134)m ($(89)m).
- U.S. Mortgage Insurance’s first-half loss ratio was 0%, versus 9% a year earlier, including a $28m favorable reserve adjustment. Canada’s loss ratio rose to 14% from 10%; Australia’s was 29%, down from 34%. Long-term care insurance’s loss ratio increased to 79% from 72%.
Balance sheet at June 30, 2018: Assets were $102.477bn, compared with $105.297bn at December 31, 2017; total equity was $14.741bn, down from $15.328bn. Cash, cash equivalents and restricted cash were $2.243bn, versus $2.875bn. Total investments were $70.882bn, versus $73.392bn. Long-term borrowings were $4.047bn, versus $4.224bn; total liabilities were $87.736bn.
Cash flow, first half: Operating activities generated $561m, down from $1.308bn. Investing activities used $198m, compared with $523m used; financing activities used $943m, compared with $755m used. Cash, cash equivalents and restricted cash decreased $632m to $2.243bn. The filing attributes the lower operating cash flow partly to prior-year trading-security sales that did not recur and current-year derivative collateral movements; financing outflows included debt repayment and net withdrawals from investment contracts.
Material changes and developments
- China Oceanwide transaction: The proposed acquisition remains pending regulatory approvals and other closing conditions. The agreed consideration is approximately $2.7bn, or $5.43 per share. CFIUS completed its review in June 2018 without unresolved national-security concerns, but other approvals remained outstanding. The parties extended their termination waiver to August 15, 2018 and stated that regulatory review was expected to extend beyond that date.
- The contemplated GLAIC unstacking was no longer being pursued at that time because the parties and Delaware regulators had not agreed on GLAIC’s fair market value. China Oceanwide did not make the previously contemplated $525m contribution for the unstacking or $600m contribution for the May 2018 notes. The parties were developing a different plan involving a potential aggregate $1.5bn contribution after closing; completion and terms remained uncertain.
- Debt refinancing: Genworth Holdings borrowed $450m under a secured term loan in March 2018, with a 6.5% rate at June 30 and maturity in March 2023. Together with $175m of cash, $441m of net proceeds funded redemption of $597m principal of 6.52% notes due in May 2018 and accrued interest. The term loan is guaranteed by Genworth Financial and has a limited-recourse guarantee secured by Genworth Canada shares.
- Capital and ratings: U.S. Mortgage Insurance reported available assets at approximately 129% of PMIERs requirements, with more than $700m of excess assets. Management said proposed PMIERs 2.0 requirements, if adopted as reviewed, would leave an excess but materially reduce the buffer. A.M. Best affirmed ratings and assigned a stable outlook on July 25, 2018, after removing its under-review status.
Outlook, risks and unusual items
- No formal full-year earnings guidance is provided. Management expects to continue long-term care rate actions, manage debt and strengthen financial flexibility. It said 2018 Canada Mortgage Insurance losses were expected to produce a full-year loss ratio above 2017’s 10%. Management also anticipated continued pressure on long-term care results from claims and benefit utilization and planned an annual claim-reserve assumption review in the third or fourth quarter of 2018; it had not yet estimated the review’s impact.
- Long-term care rate actions remain important to support claims. In the first half, Genworth received 46 approvals in 18 states, representing a weighted-average 49% increase on approximately $232m of annualized in-force premiums, and submitted 17 additional filings in seven states covering approximately $77m of annualized premiums. Rate approvals, timing, policyholder responses and the resulting financial benefit are uncertain.
- If the China Oceanwide transaction fails, management said it may pursue strategic asset sales, potentially including Canadian or Australian mortgage insurance businesses, and is evaluating options for U.S. Mortgage Insurance. It cited potential pressure on ratings, capital, debt refinancing and liquidity. The merger agreement’s regulatory and timing risks remain material.
- Investment-market sensitivity is significant: rising interest rates reduced unrealized investment gains and contributed to a $929m first-half other comprehensive loss. Management described a flattening yield curve and expected rates to rise, while noting uncertainty over timing and business impact. The portfolio was 96% investment grade; approximately 35% of cash, restricted cash and invested assets were in relatively illiquid assets.
- Claim estimates and long-term care assumptions may change materially. Management reported $244m of favorable prior-year claim development in the first half, primarily from long-term care claim terminations, but cautioned that future adverse trends could require significant reserve increases. The long-term care business recorded a first-half adjusted operating loss of $10m, versus $47m of income in the prior year.
- Unusual and accounting items: The TCJA reduced the U.S. statutory corporate rate to 21%; tax estimates remained provisional, including a $19m second-quarter expense for revaluation of foreign deferred tax balances. First-half OCI was materially negative, mainly from investment-security, hedge and foreign-currency movements. Genworth adopted several accounting standards in 2018; the filing describes adoption-related equity reclassifications and no significant adoption impact for certain standards.
- Legal matters: Genworth disclosed various insurance, shareholder and regulatory proceedings. An AXA action in England seeks more than £28m, with AXA alleging possible further losses; Genworth is defending and has counterclaimed. The filing says it generally cannot predict outcomes or estimate reasonably possible losses for pending matters. It also notes the settlement approval of shareholder class actions relating to merger disclosures.
- Genworth Financial’s common-stock dividend and share repurchase programs remained suspended. The filing reports no material changes to the risk factors from the 2017 Form 10-K. Management concluded disclosure controls were effective as of June 30, 2018.
Important facts for investors to verify
- Whether required approvals and any further extension allow the China Oceanwide transaction to close, and the final terms and timing of any post-closing capital contribution.
- The results of the planned long-term care reserve review, including claim utilization, severity, termination assumptions and the adequacy and timing of approved rate actions.
- Whether U.S. Mortgage Insurance maintains sufficient capital under existing and revised PMIERs, and how mortgage-insurance ratings, lender relationships and market share develop.
- Genworth Holdings’ liquidity, access to subsidiary dividends and ability to address the 2020 and 2021 debt maturities; also monitor term-loan covenants and collateral provisions.
- The sustainability of earnings excluding investment gains and favorable reserve adjustments, and the effect of market, foreign-exchange and valuation changes on earnings, OCI and statutory capital.
- Updates on litigation and regulatory contingencies, particularly the AXA claim and any potential adverse reserve or capital developments.