Genworth Financial, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Amounts are in millions of U.S. dollars, except per-share data. Genworth operates Retirement and Protection, International, and U.S. Mortgage Insurance businesses, plus Corporate and Other. The filing was signed November 7, 2011.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $2,521 | $2,667 | $7,744 | $7,498 |
| Income before taxes | $46 | $140 | $126 | $331 |
| Net income | $65 | $122 | $121 | $411 |
| Net income available to common stockholders | $29 | $83 | $15 | $303 |
| Diluted GAAP EPS | $0.06 | $0.17 | $0.03 | $0.61 |
| Net operating income available to common stockholders (non-GAAP) | $104 | $29 | $128 | $261 |
| Net cash from operating activities | Not presented quarterly | $2,032 | $976 |
- Quarterly revenue fell 5%, chiefly reflecting a swing in investment results: net investment losses were $157 versus gains of $105 a year earlier. Nine-month revenue rose 3%, but benefits and expenses increased 6%, reducing pretax income 62%.
- Common-stockholder net income fell 65% in Q3 and 95% for the nine-month period. The filing attributes the year-to-date decline mainly to U.S. mortgage insurance reserve strengthening, derivative-related investment losses, and the prior-year $106 tax benefit related to the separation from former parent GE.
- Net operating income is a company-defined non-GAAP measure that excludes investment gains and losses and specified items. It improved year over year in Q3 but declined for the nine months; it is not a substitute for GAAP net income.
- Net investment income increased to $842 in Q3 and $2,553 for the nine months. Weighted-average investment yield was 4.9% for Q3 and 5.0% year to date, versus 4.7% in both comparable 2010 periods.
- Net investment losses were $225 for the nine months, including $114 of net other-than-temporary impairments. Q3 net investment losses included $52 of net impairments and $76 of derivative losses.
- At September 30, total assets were $113,886, total liabilities $96,518, and total stockholders’ equity $17,368, compared with $112,395, $97,424, and $14,971, respectively, at year-end 2010. Equity’s $2.4 billion increase largely reflected unrealized investment gains and hedge-related OCI.
- Cash and cash equivalents were $3,648, up from $3,132 at year-end. Nine-month investing cash flow was positive $86, versus negative $1,688 in 2010; financing cash flow was negative $1,507, including debt repayments and investment-contract withdrawals exceeding deposits.
- Long-term borrowings were $4,708; non-recourse funding obligations were $3,280; securitization-related borrowings were $414. The company had $1.9 billion of revolving credit capacity, no facility borrowings, and $259 utilized mainly for letters of credit. Holding-company cash was $679.
The filing does not present a single conventional operating margin measure; insurance results are discussed by segment and through company-defined operating income and loss ratios.
Material changes and segment performance
- Retirement and Protection: Q3 net operating income was $120, up from $111; nine-month income was $396, up from $347. Life insurance improved, while long-term care results weakened from higher claims and lower claim termination rates on older policies. Wealth management benefited from Altegris and positive net flows; retirement income was pressured by equity-market weakness and variable-annuity guarantees.
- International: Q3 net operating income was $98 versus $121; nine-month income was $329 versus $317. Mortgage insurance faced higher losses in Australia and Canada; lifestyle protection benefited year to date from lower claims and prior repricing, but reduced consumer lending pressured sales.
- U.S. Mortgage Insurance: Q3 operating loss narrowed to $79 from $152, but nine-month operating loss widened to $413 from $228. The nine-month loss reflected a $299 reserve strengthening in Q2, primarily for lower cure rates and aging delinquencies. New insurance written increased 6% year to date, while primary insurance in-force fell 8% year over year.
- Reserves: Prior-year claim reserves increased $622 during the first nine months: $371 in U.S. mortgage insurance and $262 in long-term care insurance. Management cited weaker mortgage cure trends and greater severity and duration of claims on older long-term-care policies.
- GEMICO’s risk-to-capital ratio rose to 30.7:1 from 23.8:1 at year-end 2010, above the commonly applied 25:1 limit. A revocable North Carolina waiver and waivers in other states allowed it to write in 46 states at quarter-end; alternative underwriting arrangements and approvals remain important.
Outlook, commentary, and key risks
- Management described volatile markets, widening credit spreads, historically low Treasury yields, continued U.S. housing weakness, and uncertainty tied to the European debt crisis. It expects U.S. unemployment to remain elevated for an extended period and further home-price declines through the remainder of 2011 and into 2012.
- Management expected U.S. mortgage insurance reserve development to remain sensitive to home prices, employment, delinquencies, cure rates, foreclosure delays, and loan-modification activity. Australian mortgage insurance losses were expected to remain elevated through 2011 and begin moderating in 2012; no quantified earnings guidance was provided.
- Genworth announced after quarter-end, on November 3, a plan to pursue an Australian mortgage-insurance IPO in 2012, subject to market conditions and regulatory approval, potentially selling up to 40% while retaining control. It expects to accrue up to $80 of additional deferred tax liabilities in Q4 related to unremitted earnings.
- The Medicare supplement business sale closed October 1 for $276; Genworth expects to record a $21 gain in Q4. The company also discontinued new sales of retail and group variable annuities in January 2011, while continuing to service existing contracts.
- A new insurance-contract acquisition-cost accounting standard is expected to reduce retained earnings and equity by approximately $1.3–$1.6 billion upon adoption in 2012, subject to adjustments, and is expected to reduce future earnings through lower deferrals and amortization.
- Other risks include investment-credit losses and valuation uncertainty, derivative and counterparty exposures, reserve-estimation uncertainty, subsidiary dividend restrictions, ratings downgrades, regulatory capital constraints, litigation and investigations, and refinancing of revolving facilities maturing in 2012. The filing says it is not feasible to predict outcomes or estimate loss ranges for pending legal matters.
- The filing reports effective disclosure controls and no material change in internal control over financial reporting during the period.
Investor verification priorities
- Review the U.S. mortgage insurance reserve assumptions, cure-rate trends, delinquency aging, and potential additional capital needs; confirm the status and conditions of state waivers and GSE approvals.
- Track long-term-care claims, especially severity and duration in older policy cohorts, and the timing and scope of approved in-force premium increases.
- Assess the drivers and potential volatility of derivative-related losses, including GMWB guarantees, credit-default swaps, and securitization-entity positions.
- Evaluate the quality and liquidity of investment marks, including unrealized losses, Level 3 valuations, and sensitivity to credit spreads and structured-asset performance.
- Verify execution, regulatory approval, proceeds, and tax consequences of the proposed Australian IPO, as well as the completed Medicare supplement sale and expected Q4 gain.
- Confirm refinancing or replacement plans for the 2012 revolving facilities, holding-company liquidity, subsidiary dividend capacity, and the expected accounting transition effect on equity and earnings.