Genworth Financial, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. The filing is unaudited. Genworth operates U.S., Canadian and Australian mortgage insurance businesses, U.S. life insurance, and a runoff segment.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $2,236 | $2,157 | $4,021 | $4,292 |
| Income from continuing operations | $241 | $175 | $368 | $378 |
| Net income (loss) attributable to common stockholders | $172 | $(193) | $225 | $(39) |
| Net operating income, company-defined non-GAAP | $123 | $119 | $226 | $273 |
| Net operating income per diluted share | $0.25 | $0.24 | $0.45 | $0.55 |
| Net cash from operating activities | Not provided quarterly | Not provided quarterly | $1,066 | $511 |
- Q2 revenue increased 4%; first-half revenue declined 6%. First-half premiums fell 16% to $1,921, largely reflecting life business reinsurance and portfolio changes; policy fees and other income rose 16% to $521.
- Q2 common-stockholder earnings improved from the prior-year loss, which included a $314 million discontinued-operations loss. Q2 2016 included a $21 million discontinued-operations loss. First-half continuing-operations income was slightly lower year over year.
- Q2 benefits and expenses were $1,885, down 1%; first-half benefits and expenses were $3,520, down 6%. First-half acquisition and operating expenses rose 28% to $721, including litigation, debt-consent and restructuring costs.
- Net investment income was $779 in Q2 and $1,568 for the first half, versus $793 and $1,574, respectively. Net investment gains were $30 in Q2 and $11 for the first half; first-half 2015 had an $8 million loss.
- Q2 other comprehensive income was $895; first-half OCI was $2,171, primarily reflecting unrealized investment and hedge gains. Total equity rose to $17,009 from $14,637 at year-end 2015, while total assets rose to $108,206 from $106,431.
- At June 30, cash and cash equivalents were $3,457, down from $5,965 at year-end. Long-term borrowings were $4,191, down from $4,570; non-recourse funding obligations fell to $310 from $1,920. Total liabilities were $91,197.
- First-half cash flows: operating activities provided $1,066; investing activities used $1,284; financing activities used $2,348. Cash declined $2,536, including large redemptions of non-recourse obligations and debt.
Material changes and segment performance
- U.S. Mortgage Insurance: Q2 net operating income was $61, up from $49; first-half was $122, up from $101. Q2 loss ratio improved to 24% from 33%. Delinquencies were 25,798, with a 3.86% delinquency rate, versus 33,199 and 5.21% a year earlier. New insurance written increased 39% in Q2 to $11.4 billion.
- Canada Mortgage Insurance: Q2 net operating income was $38 versus $37; first-half was $71 versus $77. Loss ratios increased to 20% for Q2 and 22% for the first half, each up 3 percentage points, amid higher delinquencies and severity in oil-producing regions. Bulk insurance writings surged ahead of Canadian rule changes effective July 1; management expected bulk demand to decline thereafter.
- Australia Mortgage Insurance: Q2 net operating income fell to $15 from $29; first-half fell to $34 from $59. Loss ratios were 36% for Q2 and 31% for the first half, higher year over year. Delinquencies, severity and currency movements weighed on performance; management expected 2016 new insurance written below 2015.
- U.S. Life Insurance: Q2 net operating income was $55 versus $57; first-half was $146 versus $138. Long-term care improved on approved in-force rate increases and reduced benefits, but reserve refinements, new-claim severity and lower terminations were offsets. Fixed annuities moved to a $13 million Q2 operating loss, including a low-rate-driven loss-recognition charge.
- Runoff: Q2 net operating income was $6 versus $9; first-half was $10 versus $20, mainly reflecting lower variable-annuity account values and investment income.
Outlook, management commentary and risks
- No specific consolidated earnings guidance was provided. Management emphasized improving performance, reducing holding-company debt, maximizing mortgage insurance opportunities and restructuring U.S. life operations.
- U.S. life sales of traditional life and fixed annuity products were suspended March 7, 2016. Expense actions were expected to reduce annualized pretax cash expenses by about $150 million. Management expected to distribute only part of GLAIC to the holding company by the end of the first half of 2017, subject to regulatory approvals; broader separation and isolation plans remain dependent on approvals and execution.
- Management reported 52 long-term-care rate-action approvals in 14 states during the first half, covering approximately $344 million of annualized in-force premiums at a weighted-average increase of 25%; 45 additional filings covering approximately $554 million were submitted.
- Low interest rates remain a major risk. Fixed immediate annuity loss-recognition testing resulted in a $14 million DAC write-off and an $18 million reserve increase. Management estimated a further after-tax earnings charge of about $10 million from a 25-basis-point adverse interest-rate or credit-spread move, or about $15 million from 2% lower mortality, for that block. A 100-basis-point reduction in long-term rates from specified assumptions was estimated to create an approximately $115 million after-tax charge for universal and term universal life products.
- Management estimated lower investment yields could reduce investment income by approximately $10 million in the second half of 2016, $50 million in 2017 and $100 million in 2018, before tax and DAC effects; this scenario assumes yields remain at June 30 levels and excludes potential crediting-rate changes and reserve or DAC unlocking.
- Material legal exposure includes the approved $219 million securities-litigation settlement: insurers pay $150 million and Genworth paid $69 million, plus about $10 million in additional legal expenses. The settlement exhausted available 2014 executive and organizational liability insurance, leaving no coverage under that program for the separate Australian mortgage-insurance securities litigation. Other litigation and regulatory outcomes could not be estimated clearly.
- Other unusual items include the European mortgage-insurance sale completed May 9 for approximately $50 million net proceeds; a $12 million pretax gain on the term-life platform sale; and the securitization clean-up call, which recorded a $64 million investment loss and a $64 million debt-extinguishment gain, with no net-income impact.
Key facts for investors to verify
- Whether long-term-care premium increases, claims experience and reserve assumptions support continued improvement, particularly after the planned 2016 assumption review.
- Capital and regulatory compliance: U.S. mortgage insurance assets were estimated at 115% of PMIERs requirements at June 30; Canada’s MCT ratio was approximately 233% against a 220% operating target; Australia’s PCA ratio was approximately 156%.
- Holding-company liquidity and debt-reduction capacity, including the sustainability of subsidiary dividends and the effects of the terminated $300 million revolving credit facility.
- Progress, timing, regulatory approvals and capital consequences of the U.S. life restructuring and long-term-care isolation plans.
- Potential losses from remaining litigation, especially the Australian securities case without 2014 insurance coverage, and any Penn Treaty guaranty-fund assessment. No Penn Treaty liability was accrued because the amount and timing could not be estimated.
- Market sensitivity of investment valuations and derivatives: unrealized investment gains materially increased equity, while the filing notes possible future write-downs if credit or collateral performance worsens.