Genworth Financial, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Amounts are in U.S. dollars, millions except per-share data and where noted.
Business context
Genworth operates U.S. Life Insurance, International Mortgage Insurance, U.S. Mortgage Insurance, International Protection and Runoff businesses. The quarter’s results reflect stronger mortgage insurance performance and a material deterioration in long-term care (LTC) claims experience. In May, Genworth completed an IPO of 33.8% of its Australian mortgage insurance business, retaining 66.2% ownership.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $2,415 | $2,371 | $4,737 | $4,674 |
| Income from continuing operations before tax | $313 | $247 | $619 | $484 |
| Net income | $228 | $180 | $447 | $321 |
| Net income available to common stockholders | $176 | $141 | $360 | $244 |
| Diluted continuing-operations EPS | $0.35 | $0.27 | $0.72 | $0.52 |
| Net operating income (non-GAAP) | $158 | $133 | $352 | $284 |
| Operating cash flow | Not presented by quarter | $578 | $646 |
Q2 revenue rose 2% year over year; pretax continuing income rose 27%. Six-month revenue rose 1%, while common-stockholder net income increased 48%. Lower mortgage insurance losses and investment gains contributed to the improvement; LTC claims severity and frequency were adverse. Net operating income is a company-defined non-GAAP measure and excludes, among other items, investment gains and losses.
- Q2 net investment income was $813, down from $821; six-month income was $1,618, down from $1,635. Annualized weighted-average investment yield was 4.6% in both the quarter and first half, versus 4.8% and 4.7%, respectively, in 2013.
- Net investment gains were $34 in Q2 versus $21; for the first half, gains were $17 versus a $40 loss. Six-month other-than-temporary impairments were $3 versus $17.
- Other comprehensive income was $796 in Q2 and $1,706 for the first half, compared with losses of $1,761 and $2,166 in 2013. The 2014 gains largely reflected higher unrealized investment values and hedge gains; they are not equivalent to operating earnings.
- At June 30, total assets were $111,644, total liabilities $93,380 and total equity $18,264. Cash and equivalents were $4,138. Long-term borrowings were $4,691, down from $5,161 at year-end 2013; total liabilities also include $2,024 of non-recourse funding obligations.
- For the first half, investing cash flow was $(938) and financing cash flow was $230; cash declined $76 to $4,138. Operating cash flow fell from $646 a year earlier, chiefly as higher tax payments were partly offset by lower claims payments.
Material changes and segment results
- U.S. Life Insurance: Q2 net operating income fell to $69 from $79, primarily because LTC results deteriorated; first-half income was $163, nearly flat with $164. Q2 LTC net operating income was $6 versus $26.
- International Mortgage Insurance: Q2 net operating income increased to $97 from $89; first-half income rose to $196 from $170. Lower claims helped, while reported revenue was pressured by foreign exchange and the seasoning of older Canadian books.
- U.S. Mortgage Insurance: Q2 net operating income rose to $39 from $13; first-half income rose to $72 from $34. The U.S. mortgage insurance loss ratio declined to 43% in Q2 from 70%, and to 45% for the first half from 66%, reflecting fewer new delinquencies and improved cures and aging. First-half reserves included $17 of strengthening.
- International Protection: First-half net operating income was $9 versus $7. Management expected only slightly positive earnings in 2014 if European conditions remained stable and did not improve materially.
- Runoff: First-half net operating income was $27 versus $22, benefiting from equity-market performance in variable annuity products.
Outlook, risks and unusual items
- LTC reserve review: Management cited meaningful adverse claims experience in Q2, including a $39 increase in prior-year claim reserves. A comprehensive review of LTC claim reserves and assumptions was underway, with completion expected before Q3 results. Management said assumptions could change and reserves could increase, possibly materially. The review also could affect LTC margins.
- U.S. mortgage insurer capital: Draft GSE eligibility standards (PMIERs) were expected to require an estimated additional $450–$550 of capital for full compliance assuming a June 30, 2015 effective date, falling below $175 by December 31, 2016. The estimate is preliminary and depends on final rules, business performance, and access to capital and reinsurance. Genworth had contributed $300 to its primary U.S. mortgage insurer in Q2; its reported risk-to-capital ratio was 14.0:1 versus the current 25:1 maximum.
- Capital and liquidity: The Australian IPO generated approximately $541 gross proceeds; approximately $500 net proceeds were received at the holding company after related transactions and costs. Genworth repaid $485 of notes maturing in June and Genworth Canada issued CAD$160 of 2024 notes to refinance CAD$150 due in 2015. Management stated that available holding-company cash and expected subsidiary dividends, among other sources, were expected to provide liquidity flexibility. Insurance subsidiary dividends are regulated; the company did not expect subsidiaries to distribute the full approximately $1.0 billion available without regulatory approval in 2014.
- Shareholder returns: Common-stock dividends and share repurchases remained suspended indefinitely, subject to board discretion.
- Legal matters: A new securities class action concerned 2012 disclosures about the Australian mortgage insurance business and a planned IPO. Bank of America/Countrywide mortgage insurance arbitrations resolved the rescission portion, with curtailment and denial disputes remaining; a hearing was scheduled to begin in March 2015. A court granted summary judgment for Genworth in the Hill captive-reinsurance case; other related actions continued. The company could not estimate possible losses and had not accrued amounts for the identified matters.
- Other items: Genworth recorded a $2 after-tax loss on early debt extinguishment in Q2. The prior-year comparison included $13 of after-tax restructuring expense and discontinued-operations results. The filing cautions that actual results may differ materially from forward-looking statements, including due to reserve assumptions, interest and credit markets, mortgage conditions, regulation, litigation, reinsurance availability and capital requirements.
Most important facts for investors to verify
- Outcome of the LTC claims-reserve review, any assumption changes, and the resulting reserve, earnings and statutory-capital effects.
- Final PMIERs requirements, timing and transition relief, and Genworth’s actual funding plan and capital needs.
- Whether improving U.S. mortgage delinquencies and loss ratios persist, and the effect of older loan vintages and reserve strengthening.
- Holding-company liquidity, regulated subsidiary dividend capacity, debt maturities and the status of the suspended dividend and buyback.
- Developments and potential financial exposure in the remaining mortgage insurance disputes and the new securities litigation.