Genworth Financial, Inc. — 2015 Q2 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Dollar amounts below are in millions unless noted. Genworth operates international and U.S. mortgage insurance, U.S. life insurance, runoff, and corporate businesses. The lifestyle protection insurance business was reclassified to discontinued operations after the board approved a sale in June; prior periods were recast.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $2,157 | $2,194 | $4,292 | $4,310 |
| Income from continuing operations before tax | $245 | $308 | $539 | $605 |
| Income from continuing operations | $175 | $224 | $378 | $434 |
| Net income (loss) attributable to common stockholders | $(193) | $176 | $(39) | $360 |
| Continuing-operations EPS, diluted | $0.24 | $0.34 | $0.55 | $0.69 |
| Net EPS, diluted | $(0.39) | $0.35 | $(0.08) | $0.72 |
| Net operating income (non-GAAP) | $119 | $154 | $273 | $340 |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $511 | $578 |
Q2 continuing pretax margin was approximately 11.4%, compared with 14.0% a year earlier; six-month margin was approximately 12.6%, versus 14.0%. Net operating income is a company-defined non-GAAP measure and excludes specified items, including discontinued operations and investment gains or losses.
- Q2 performance: Continuing-operations income fell $49 year over year as revenue declined $37 and benefits and expenses increased $26. The common-stockholder net loss was principally driven by the $314 after-tax discontinued-operations loss.
- Six-month performance: Continuing-operations income declined $56; net operating income fell $67. U.S. Mortgage Insurance net operating income improved to $101 from $72, while International Mortgage Insurance fell to $125 from $196 and U.S. Life Insurance to $138 from $163.
- Cash flows: Six-month investing cash outflow was $1,261, versus $938 in 2014; financing cash inflow was $127, versus $230. Continuing-operations cash and cash equivalents were $4,100 at June 30, down from $4,716 at year-end.
- Balance sheet and debt: Total assets were $109,164, versus $111,358 at December 31, 2014; total stockholders’ equity was $15,727, versus $16,797. Long-term borrowings were $4,607, non-recourse funding obligations $1,967, and securitization-related borrowings $199. The filing does not present a single consolidated debt total that combines these categories.
- Investment income and OCI: Net investment income was $793 in Q2 and $1,574 for six months. Annualized weighted-average investment yield was 4.5% in both the quarter and first half, compared with 4.6% in the 2014 comparable periods. Six-month other comprehensive loss was $1,289, primarily reflecting lower unrealized investment gains and losses on hedge derivatives.
Material changes and unusual items
- In June, the board approved the sale of lifestyle protection insurance. Genworth recorded a $458 impairment/write-down, resulting in a $306 after-tax loss in discontinued operations for both Q2 and the six-month period. On July 22, Genworth said it had received an irrevocable offer from AXA and was in exclusive negotiations. Expected price was €475 million (about $510 million); estimated net proceeds after pension settlement and closing costs were about $400 million. Closing was expected by year-end 2015, subject to consultation, regulatory approvals, and other conditions.
- Genworth sold an additional 14.2% of its Australian mortgage insurance business in May, reducing ownership to 52.0% and generating approximately $226 million of net proceeds. The reduced ownership also increased income attributable to noncontrolling interests.
- In July, the U.S. mortgage insurance business executed two excess-of-loss reinsurance transactions expected to provide about $300 million of PMIERs capital credit and an intercompany preferred-security sale providing about $200 million of additional available assets. One reinsurance transaction still awaited final GSE approval; a planned internal restructuring also required regulatory approval.
- After quarter-end, an Australian mortgage insurance subsidiary issued AUD$200 million of subordinated floating-rate notes due 2025 and used proceeds partly to redeem AUD$90 million of existing debt.
- Six-month unrealized investment gains attributable to Genworth declined to $1,628 from $2,453 at year-end 2014. Management attributed investment valuation pressure to interest-rate and credit-spread movements.
Outlook, management commentary, and risks
- Capital and strategy: Management previously estimated the U.S. mortgage insurance business needed $500–$700 million of additional capital to meet final PMIERs by December 31, 2015. After giving effect to subsequent transactions and a planned restructuring, management believed the business would meet the requirements, while seeking additional capital flexibility. Execution, valuation, approvals, and market conditions remain uncertain.
- Long-term care insurance: Management expected 2015 earnings to be modest and variable. It plans further in-force premium rate actions, risk reduction and reinsurance initiatives. Approval levels and timing vary by state, and claims experience, assumptions, and policyholder responses could require further reserve changes. Six-month long-term care loss ratio was 73%, versus 68%.
- Cost program: Strategic plans included a multi-step restructuring targeting cash savings in excess of $100 million by the end of 2016. Q2 included $2 million of after-tax restructuring expense.
- Operating environment: Management cited low interest rates and reinvestment yields, foreign-exchange pressure, uncertain global growth, and housing and mortgage market conditions. The Australian business lost a major customer for new business effective May 2015; the customer represented 10% of 2014 new insurance written and 14% of gross written premiums.
- Legal and regulatory matters: Two securities class actions concerning disclosures about long-term care reserves and the Australian mortgage insurance business remained pending; courts denied motions to dismiss. A Minnesota consent order imposed a $90,000 penalty and barred new lender-affiliated captive mortgage reinsurance business for 10 years. Genworth said it could not estimate the range of possible losses for other pending matters.
- Controls: Management concluded disclosure controls were ineffective as of June 30 because of a previously identified material weakness in controls over implementation and review of long-term care claim-reserve methodology changes. Remediation and effectiveness testing were in progress, with testing planned for 2015.
- Shareholder distributions: Common dividends and stock repurchases remained suspended indefinitely. Genworth also noted that insurance-subsidiary dividends are restricted by regulation; although estimated 2015 dividend capacity without approval was about $500 million, the company did not expect subsidiaries to distribute that amount.
Most important facts for investors to verify
- Whether the AXA lifestyle protection sale closed, at what final price and net proceeds, and how final adjustments affected the recorded loss.
- Whether all PMIERs transactions and the internal restructuring received required GSE and regulatory approvals, and whether the U.S. mortgage insurance business met requirements by the deadline.
- Long-term care claims, reserve assumptions, premium-rate approvals, and whether the reserve-control weakness was remediated and tested effectively.
- Trends in mortgage-insurance delinquencies and claims, particularly older U.S. books and Australian delinquencies, customer retention, and foreign-exchange effects.
- Holding-company liquidity, debt reduction progress, subsidiary dividend capacity, and the effect of ratings or capital requirements on funding and business relationships.