Genworth Financial, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Comparisons are with the corresponding 2016 periods unless noted. Dollar amounts are in millions except per-share data. Genworth operates U.S., Canadian and Australian mortgage insurance, U.S. life insurance, and runoff businesses.
Financial results and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $2,215 | $2,150 | $6,609 | $6,171 |
| Income (loss) from continuing operations before tax | $286 | $(125) | $1,019 | $376 |
| Net income (loss) available to common stockholders | $107 | $(380) | $464 | $(155) |
| GAAP diluted EPS | $0.21 | $(0.76) | $0.93 | $(0.31) |
| Adjusted operating income (loss) available to common stockholders | $76 | $(405) | $370 | $(179) |
| Net cash from operating activities | — | $1,932 | $1,798 | |
| Net cash used by investing activities | — | $(678) | $(2,050) | |
| Net cash used by financing activities | — | $(1,270) | $(2,699) |
Revenue rose 3% in Q3 and 7% year to date. Nine-month premiums increased to $3,382 from $3,029, while policy fees and other income fell to $619 from $738. Net investment gains were $85 in Q3 and $220 year to date, versus $20 and $31, respectively, in 2016; derivatives contributed substantially to the 2017 gains. Q3 benefits and expenses fell to $1,929 from $2,275, principally reflecting the prior-year long-term-care claim-reserve review. The nine-month effective tax rate was 34.1%, compared with 94.5% in 2016, when a $265 deferred-tax-asset valuation allowance affected results.
Balance sheet at September 30, 2017: Total assets were $104,629; total liabilities $89,542; total equity $15,087; cash and cash equivalents $2,836; and long-term borrowings $4,224, compared with $4,180 at December 31, 2016. Genworth Holdings, the parent borrowing entity, held $754 in cash and equivalents, including $52 of restricted assets. Insurance-subsidiary assets are subject to regulatory dividend restrictions.
Other financial measures: Cash and invested assets totaled $75.9 billion. Fixed-maturity securities were 96% investment grade. The U.S. mortgage insurer’s PMIERs available assets were approximately 122% of required assets, with more than $500 million of excess. Its risk-to-capital ratio was approximately 12.9:1, below the 25:1 regulatory maximum. Canada’s mortgage insurer reported an MCT ratio of approximately 165%, above the 150% supervisory target; Australia’s estimated PCA ratio was approximately 184%.
Material changes and operating performance
- Mortgage insurance: U.S. and Canada mortgage results benefited from lower delinquencies, favorable cures and reserve development. Nine-month loss ratios were 13% for U.S. mortgage insurance and 11% for Canada. U.S. primary insurance in-force grew 11% year over year to $148.0 billion, although Q3 new insurance written declined 12%. Canada’s new insurance written fell 52% in Q3 and 51% year to date, amid market and regulatory changes. Australia’s Q3 loss ratio improved to 37% from 42%, but management expected the full-year 2017 ratio to exceed 2016’s 34%.
- U.S. life insurance: Nine-month adjusted operating income improved to $91 from a $61 loss. Long-term care contributed $42 versus a $199 loss, largely because the prior-year period included reserve strengthening; its nine-month loss ratio was 74% versus 94%. Life insurance adjusted income declined to $6 from $110, including unfavorable mortality, assumption/model effects and runoff. Fixed annuities improved to $43 from $28.
- Long-term care reserves and DAC: Following lower interest rates and higher unrealized investment gains, the company reduced LTC deferred acquisition costs to zero and increased future policy benefit reserves by approximately $333. These shadow-accounting adjustments were recorded in other comprehensive income, with no net-income impact. Future assumptions and loss-recognition testing remain important sources of potential volatility.
- Capital and debt: Consolidated cash was nearly unchanged from year-end, while operating cash flow improved. Financing outflows were lower than in 2016, when the company redeemed $1.62 billion of non-recourse funding obligations and repaid or repurchased $362 of long-term debt. No long-term debt repayment was reported in 2017 year to date.
Outlook, transaction, risks and unusual items
- China Oceanwide merger: China Oceanwide agreed to acquire Genworth for approximately $2.7 billion, or $5.43 per share in cash; stockholders approved the merger. Closing remained subject to regulatory approvals and other conditions. The parties withdrew their joint CFIUS notice on October 2, 2017 to develop additional mitigation measures and intended to refile. They had extended the termination deadline to November 30, 2017 and were discussing a further extension.
- Funding and alternatives: In connection with the merger, China Oceanwide committed $600 million toward Genworth’s May 2018 debt maturity and $525 million for U.S. life businesses; Genworth Holdings had separately committed $175 million to the U.S. life restructuring. If the deal or refinancing does not proceed, management said asset sales may be required, potentially including the Canadian or Australian mortgage insurance businesses. A potential partial sale to protect U.S. mortgage insurance from ratings pressure was also under evaluation.
- Management priorities and guidance: Management emphasized long-term-care rate actions, business restructuring, reducing debt and preserving capital flexibility. No quantified consolidated earnings guidance was provided. In Q4 2017, the company planned assumption reviews and loss-recognition testing for life and annuity businesses, and an Australian mortgage insurance premium-earnings-pattern review. Results could materially affect margins, reserves, DAC and reported earnings.
- Ratings and liquidity risks: Ratings actions during 2017 included S&P downgrades of principal U.S. life subsidiaries and a negative CreditWatch for the U.S. mortgage insurer, and Moody’s downgrades of Genworth Holdings debt and U.S. life subsidiaries. Management warned of uncertain access to refinancing and capital, pressure on business volumes and potential collateral or counterparty consequences. The May 2018 maturity is a key near-term funding exposure. Common-stock dividends and repurchases remained suspended.
- Long-term care and legal contingencies: Rate increases are subject to state approval and may take years to implement. For the first nine months, 75 approvals across 32 states represented a weighted-average 27% increase on approximately $457 million of annualized in-force premiums; 131 additional filings were submitted. Penn Treaty’s liquidation led to a $21 million assessment accrual in Q1, with $14 million of net guaranty-fund assessments reported for the nine-month period. A proposed $20 million settlement of securities litigation was awaiting final court approval; other litigation exposures were not estimable from the filing.
- Other unusual items: Q3 2017 included a $9 million after-tax loss related to the sale of the lifestyle-protection business. A new clearing-party margin accounting treatment reduced derivative assets by $509 million and derivative liabilities by $274 million in Q3; this was a balance-sheet presentation change, not an equivalent cash loss.
Important facts for investors to verify
- Whether CFIUS and other regulators approved the China Oceanwide transaction, whether the parties extended the November 30, 2017 deadline, and whether the committed funding is available if the merger closes.
- How Genworth will address the May 2018 debt maturity if the transaction is delayed or fails, including refinancing terms, asset-sale plans and holding-company liquidity.
- The outcome of Q4 2017 actuarial reviews and loss-recognition testing, particularly LTC claim assumptions, reserve margins, premium-rate approvals and potential DAC or reserve charges.
- Whether ratings and regulatory capital remain adequate to support mortgage insurance eligibility, new business and subsidiary dividend capacity.
- Whether favorable mortgage claim trends persist and whether Australia’s expected full-year loss-ratio pressure materializes.