GENWORTH FINANCIAL INC quarterly report, Q2 FY2012

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Genworth Financial, Inc. — 2012 Q2 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2012. Unaudited consolidated results; amounts below are in U.S. dollars unless stated otherwise. Genworth operates life insurance, international protection, wealth management, mortgage insurance and runoff businesses.

Financial performance and position

  • Second-quarter revenue: $2.523 billion, down 5% from $2.655 billion a year earlier. Premiums fell 11% to $1.302 billion; net investment income fell 4% to $846 million. Fees and other income rose 14% to $409 million.
  • Second-quarter earnings: Pretax income was $166 million, compared with a $105 million loss in Q2 2011. Net income attributable to Genworth common stockholders was $76 million, or $0.16 per diluted share, versus a $136 million loss, or $0.28 per share. Benefits and expenses declined 15% to $2.357 billion.
  • First-half results: Revenue was $4.949 billion, down 5%. Pretax income was $268 million versus $8 million; net income available to common stockholders was $123 million, or $0.25 per diluted share, versus a $77 million loss. Net operating income, a non-GAAP measure, was $111 million versus a $38 million loss.
  • Cash flow: For the first six months, operating cash flow was $220 million versus $842 million; investing cash flow was negative $106 million and financing cash flow negative $725 million. Cash and cash equivalents declined $614 million from year-end to $3.874 billion.
  • Balance sheet and debt: Total assets were $112.536 billion and stockholders’ equity $16.966 billion at June 30, compared with $112.187 billion and $16.178 billion at December 31, 2011. Long-term borrowings were $4.865 billion; non-recourse funding obligations were $2.598 billion; securitization-related borrowings were $375 million. The filing does not provide a single consolidated liquidity or debt ratio.
  • Investment portfolio: Cash, cash equivalents and invested assets totaled $76.875 billion. Net unrealized investment gains attributable to Genworth were $2.016 billion, up from $1.485 billion at year-end. Net other-than-temporary impairment losses were $39 million in Q2 and $56 million in the first half.

Material changes and operating drivers

  • The improvement in consolidated GAAP earnings primarily reflected much lower U.S. Mortgage Insurance losses versus 2011, when Genworth strengthened reserves by $299 million in Q2. U.S. Mortgage Insurance still recorded a $25 million operating loss in Q2 and a $68 million operating loss in the first half of 2012.
  • U.S. Life Insurance operating income fell 36% to $64 million in Q2 and 33% to $128 million in the first half. The first-half comparison included a $41 million after-tax loss from a life-block transaction involving reinsurance and repurchase of non-recourse funding obligations, as well as a $142 million DAC write-off tied to the reinsurance treaty.
  • International Protection operating income fell to $3 million in Q2 from $25 million and to $8 million in the first half from $50 million. Management cited reduced European consumer lending, lower premiums, foreign exchange effects and higher loss ratios.
  • International Mortgage Insurance operating income was $76 million in Q2 versus $78 million, and $83 million in the first half versus $177 million. Australian results were pressured by an $82 million first-quarter reserve strengthening and elevated claim frequency and severity. Canadian Q2 operating income improved to $41 million from $28 million.
  • Wealth Management operating income was $12 million in Q2 and $24 million in the first half. The sale of the GFIS unit on April 2 for about $79 million plus contingent consideration produced a $15 million after-tax gain, excluded from operating income. Assets under management ended the quarter at $22.320 billion, down from $25.930 billion a year earlier, including the divested business.

Outlook, risks and unusual items

  • Management said U.S. Mortgage Insurance could return to profitability at some point in 2013, conditional on no significant deterioration in housing or broader economic conditions. The subsidiary GEMICO’s risk-to-capital ratio was 34.3:1 versus a 25:1 statutory standard; a revocable waiver was extended through July 31, 2014. Florida suspended GEMICO’s license for new business, with new business there written through an affiliate.
  • Management planned another round of long-term-care in-force rate increase requests in Q3 2012, targeting average increases above 50% for older policies and above 25% for an earlier newer-generation block over five years. If approved and fully implemented, the increases could add approximately $200 million to $300 million in annual premiums; timing and approvals are uncertain.
  • The planned minority IPO of the Australian mortgage insurance business was moved from 2012 to early 2013, subject to market conditions, valuation, performance and regulatory approval. Moody’s had placed the Australian business under review for possible downgrade.
  • The August 2012 $930 million revolving credit facility was approaching maturity; Genworth said it did not currently plan to extend or replace it. The separate $930 million facility matured in May 2012 and was not renewed. Holding-company cash and cash equivalents were $1.0 billion at June 30. The company’s common-stock dividend remained suspended.
  • Moody’s downgraded U.S. life subsidiaries to A3 from A2 in June and placed the holding company and U.S. mortgage insurance business on review for downgrade. Holding-company senior debt was rated Baa3, Moody’s lowest investment-grade rating.
  • Two mortgage-insurance arbitrations brought by Bank of America and related claimants sought damages exceeding $834 million, plus interest and punitive damages. A CFPB civil investigative demand concerned captive reinsurance arrangements; related putative class actions alleged RESPA violations. Genworth said outcomes and loss ranges could not be estimated and no amounts were accrued.
  • Other key risks include long-term-care claims and persistency, mortgage delinquencies and claim severity, capital and regulatory requirements, investment credit and valuation risk, low interest rates, foreign exchange and the European economic environment. Management stated that expected losses on securities in unrealized-loss positions were recoverable, but acknowledged that weaker-than-expected collateral or issuer performance could lead to future write-downs.
  • Accounting changes adopted retrospectively in 2012 altered acquisition-cost accounting and prohibited negative reserves on individual level-premium term-life policies. The DAC change reduced retained earnings and equity by $1.3 billion as of January 1, 2011; prior-period results were restated. Management said the reserve-method change reduced first-half 2012 net income by $6 million.

Important facts for investors to verify

  • Whether the August 2012 revolving facility was renewed, replaced or allowed to mature, and the resulting holding-company liquidity and funding plan.
  • Progress on GEMICO’s capital position, state waivers and ability to write new business, including the status of Florida and GSE approvals.
  • Further development of U.S. Mortgage Insurance delinquencies, reserves, paid claims and the conditional 2013 profitability outlook.
  • Australian mortgage insurance claim severity, reserve adequacy, ratings review and the revised IPO timetable.
  • Long-term-care rate increase approvals, implementation timing and whether experience supports management’s premium and profitability expectations.
  • Updates on the $834 million-plus mortgage-insurance arbitrations, CFPB inquiry and RESPA class actions; no loss estimate or accrual was disclosed.