Genworth Financial, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Amounts are in millions of dollars, except per-share data. Genworth operates U.S., Canadian and Australian mortgage insurance businesses, U.S. life insurance businesses, and runoff operations.
Financial results and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $2,150 | $2,100 | $6,171 | $6,392 |
| Pre-tax income (loss), continuing operations | $(125) | $(351) | $376 | $188 |
| Net income (loss), continuing operations | $(347) | $(217) | $21 | $161 |
| Net loss attributable to common stockholders | $(380) | $(284) | $(155) | $(323) |
| Net operating income (loss), non-GAAP | $(405) | $64 | $(179) | $337 |
| Operating cash flow | — | — | $1,798 | $1,158 |
Q3 loss per common share was $0.76, compared with $0.57 a year earlier; nine-month loss per share was $0.31, versus $0.65. Total revenue fell 3% for the nine-month period, chiefly as premiums declined 11%; Q3 revenue rose 2%. Net investment income was $805 in Q3 and $2,373 for nine months. Q3 net investment gains were $20, compared with losses of $51 in Q3 2015.
- Balance sheet at September 30: Assets were $108,852, liabilities $92,103 and total equity $16,749, compared with $106,431, $91,794 and $14,637, respectively, at December 31, 2015. Equity growth largely reflected higher unrealized investment and hedge gains.
- Cash and liquidity: Cash and equivalents were $3,078, down from $5,965 at year-end 2015. Nine-month investing cash outflow was $2,050 and financing cash outflow was $2,699. Holding company Genworth Holdings had $1,065 cash; management said it was above its target liquidity level.
- Debt: Long-term borrowings were $4,194, down from $4,570. Non-recourse funding obligations fell to $310 from $1,920, primarily after $1,620 of redemptions associated with a life-block transaction. Interest expense for nine months was $262, versus $315.
- Insurance reserves: Liability for policy and contract claims rose to $8,869 from $8,095. Long-term-care claims represented $7,654, up from $6,749; the filing cautions that reserve estimates may require material future adjustments.
Material changes and unusual items
- Long-term-care insurance was the main source of Q3 deterioration. The annual claims review increased gross claim reserves by $460 and reinsurance recoverables by $25 (net reserve increase of $435); the associated after-tax charge was reported as $283. Updated assumptions included lower claim-termination rates for longer-duration claims, revised utilization assumptions and changes to incurred-but-not-reported reserves.
- A $265 valuation allowance against deferred tax assets was recorded in Q3, principally for foreign tax credits no longer expected to be realized. This contributed to a $222 tax provision despite a Q3 pre-tax loss. The nine-month tax provision was $355.
- Genworth recorded a $455 DAC impairment in 2015 related to a term-life block transaction; it did not recur in 2016, helping reduce reported DAC amortization. In 2016, the company also recorded fixed-immediate-annuity reserve increases of $18 in Q2 and a further $6 in Q3, amid low interest rates.
- Other 2016 items included a $64 pre-tax gain on extinguishment of securitization debt, $20 pre-tax make-whole expense on the January debt redemption, $18 of bond-consent solicitation fees, and $69 paid by Genworth toward a securities-litigation settlement, plus $10 of related legal fees.
- Segment non-GAAP results for nine months included U.S. Mortgage Insurance income of $189 (up from $138), Canada Mortgage Insurance income of $107 (down from $115), Australia Mortgage Insurance income of $48 (down from $80), U.S. Life Insurance loss of $61 (versus income of $178), and Runoff income of $22 (up from $16). U.S. Life’s result reflected a $199 long-term-care loss, partly offset by life-insurance income of $110.
Outlook, management commentary and risks
- On October 21, 2016, Genworth agreed to be acquired by China Oceanwide for $5.43 per share in cash, an approximate $2.7 billion transaction value. China Oceanwide also committed $600 to address 2018 debt maturity and $525 for the U.S. life businesses’ restructuring. Completion requires shareholder, regulatory and other approvals; no assurance of closing is given.
- Management’s stated priorities are improving performance, reducing leverage, increasing flexibility, and separating and isolating the long-term-care business from other U.S. life businesses. If the transaction fails, management says it will continue exploring strategic alternatives, including possible sales of Canadian or Australian mortgage insurance businesses and/or part of U.S. mortgage insurance.
- Management expects Q4 2016 long-term-care loss-recognition and statutory cash-flow testing to reflect the revised assumptions and potentially materially reduce margins. Further reserve increases, additional DAC amortization, and regulatory approval and timing of premium rate actions are significant uncertainties. For nine months, approved long-term-care rate increases averaged 29% on approximately $584 of annualized in-force premiums; 71 additional filings were submitted.
- Low interest rates pressure life, annuity and long-term-care profitability and increase reinvestment risk. The company estimated that, if investment yields stayed at September 30 levels, investment income could be reduced by approximately $50 in 2017 and $100 in 2018, before taxes and other adjustments.
- Rating actions, capital and liquidity constraints, regulatory changes, mortgage-market conditions, reinsurance and counterparty risk, and litigation are material risks. The company reported that mortgage-insurer PMIERs available assets were approximately 117% of requirements, with more than $400 of excess; GMICO’s statutory risk-to-capital ratio was about 15.0:1 against a 25:1 maximum. Canada’s MCT ratio was approximately 236%; a proposed new capital framework was expected to take effect in 2017.
- Genworth’s common-stock dividend and repurchases remain suspended indefinitely. Subsidiary dividends are subject to regulatory restrictions; the filing reports $14.8 billion of restricted net assets at subsidiaries.
Important facts for investors to verify
- Whether the China Oceanwide transaction receives required shareholder and regulatory approvals, and whether the promised capital contributions and debt support are delivered.
- Q4 long-term-care loss-recognition and statutory cash-flow testing results, subsequent reserve changes, and the feasibility and approval of planned premium increases or benefit modifications.
- Insurance-subsidiary capital, ratings, dividend capacity and Genworth Holdings’ liquidity and ability to refinance 2018 debt, particularly if the transaction does not close.
- Long-term-care claim trends, including claim termination, utilization and severity; mortgage-insurance delinquencies and losses in Canada and Australia; and the effect of low rates on annuity reserves and investment income.
- Potential additional litigation exposure. The filing describes a securities class-action settlement and other pending securities, derivative and insurance-related matters; it states that some outcomes and reasonably possible losses cannot be estimated clearly.
The company stated that disclosure controls and procedures were effective as of September 30, 2016. The filing provides no conventional numerical earnings guidance.