GENWORTH FINANCIAL INC quarterly report, Q2 FY2010

Genworth Financial, Inc. — Q2 2010 Form 10-Q

Reporting period: Three and six months ended June 30, 2010; compared with the same 2009 periods. Unless otherwise noted, amounts are in millions of U.S. dollars. Genworth operates Retirement and Protection, International, and U.S. Mortgage Insurance businesses.

Financial results and liquidity

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Total revenue	$2,410	$2,483	$4,831	$4,217
Net income (loss)	$77	$(50)	$289	$(519)
Net income (loss) attributable to common stockholders	$42	$(50)	$220	$(519)
Diluted earnings (loss) per share	$0.08	$(0.11)	$0.45	$(1.20)
Net operating income attributable to common stockholders	$118	$9	$232	$23
Net cash from operating activities	Not stated by quarter	$557	$1,369

Q2 revenue fell 3% year over year; first-half revenue rose 15%, reflecting, among other items, substantially lower investment losses than in 2009. Net investment losses were $139 in Q2 and $209 for the first half, versus $53 and $823, respectively, in 2009.
Q2 common-stockholder income improved from a loss, mainly as U.S. mortgage-insurance losses moderated. First-half results also benefited from lower investment losses and a $106 tax benefit related to Genworth’s separation from GE. The tax benefit is excluded from reported net operating income.
Net operating income is a non-GAAP measure that excludes after-tax investment gains and losses and specified unusual items; it is not a substitute for GAAP net income.
First-half operating cash flow declined to $557 from $1,369. Investing cash flow was $(723), principally as investment purchases exceeded maturities and sales; financing cash flow was $(243). Cash and cash equivalents were $4,586 at June 30, down from $5,002 at year-end.
Total assets were $110,352 and total liabilities $95,305 at June 30. Stockholders’ equity was $15,047, up from $13,350 at December 31, 2009, including a substantial improvement in accumulated other comprehensive income as investment markets recovered.
Debt and financing included $730 of short-term borrowings, $4,331 of long-term borrowings, $3,437 of non-recourse funding obligations, and $525 of securitization-related borrowings. Genworth issued $400 of 7.70% senior notes due 2020; Genworth Canada issued CDN$275 of 5.68% notes due 2020. The parent had $916 of cash; revolving facilities provided $1.9 billion of access, with $1.1 billion unused.
Q2 and first-half U.S. Mortgage Insurance loss ratios remained high at 141% and 140%, respectively, though below 225% and 231% in 2009. International Mortgage Insurance loss ratios were 42% and 43%, down from 56% and 53%.

Material changes and business developments

Retirement and Protection first-half net operating income increased to $236 from $161. Retirement income improved notably, while life insurance operating income declined $27, mainly due to higher term-life mortality and lower persistency. Long-term care income was affected by aging policies, higher claims in older blocks, and lower terminations.
International first-half net operating income increased to $196 from $188. Mortgage-insurance claims improved in Canada and Australia; lifestyle-protection results benefited from fewer new claims and repricing, partly offset by weaker consumer lending and lower sales. Genworth’s ownership of Genworth Canada is 57.5% following its 2009 IPO.
U.S. Mortgage Insurance first-half net operating loss narrowed to $76 from $269. The improvement reflected lower reserve increases and loss-mitigation benefits, partly offset by higher paid claims and lower premiums. U.S. primary delinquency was 12.39% at June 30, versus 13.73% at year-end 2009 and 10.85% a year earlier.
First-half U.S. mortgage-insurance loss mitigation reduced estimated loss exposure by approximately $450, versus $333 in 2009. The company cautioned that loan modifications can re-default and that future benefits from modifications, rescissions, and settlements are uncertain.
Consolidation guidance adopted January 1, 2010 required consolidation of certain variable-interest and securitization entities. The adoption produced a $104 after-tax reduction to retained earnings, partly offset by a $91 increase to accumulated other comprehensive income. Consolidated securitization entities had $912 of assets and $708 of liabilities at June 30; assets are restricted, and most obligations have no recourse to other group entities, subject to stated limited recourse.

Outlook, risks, contingencies, and unusual items

No specific earnings or financial guidance was provided. Management described an uncertain outlook amid European sovereign-debt concerns, market volatility, weak U.S. housing conditions, and uneven economic recovery. It expected Canadian and Australian mortgage-insurance trends to remain key drivers and warned that Canadian and Australian originations could slow in the second half of 2010.
Management reported that structured-security impairments had moderated and expected losses to moderate further, but acknowledged that weaker-than-expected collateral performance could cause future write-downs. Net other-than-temporary impairments were $51 in Q2 and $131 for the first half, compared with $152 and $749 in 2009.
At June 30, investment securities had $2,342 of gross unrealized losses; management considered these losses temporary based on expected cash flows and stated it did not intend, and was not more likely than not required, to sell the affected securities before recovery. The filing warns that adverse collateral or issuer performance could lead to additional impairments.
U.S. mortgage-insurance risks include persistent unemployment and home-price weakness, elevated delinquencies and foreclosure progression, exposure to 2005–2007 books, rescission disputes, and possible exhaustion of captive-reinsurance tiers. The U.S. segment had $1,952 of reserves; Florida represented 20% of those reserves and had a 28.86% primary delinquency rate.
Other material exposures include long-term-care morbidity, mortality and persistency assumptions; annuity guarantees and hedging; interest rates, credit spreads and foreign exchange; counterparty and reinsurance risk; and access to subsidiary dividends and capital markets. Common-stock dividends remained suspended indefinitely.
The company faces ordinary-course litigation and regulatory inquiries, including matters involving mortgage-insurance practices, rescissions, sales and underwriting, and customer claims. Management said it could not reasonably estimate outcomes or potential losses; no material new proceedings or developments were reported for the period.
After quarter-end, adoption of accounting guidance on embedded credit derivatives was expected to reduce retained earnings by approximately $270 before taxes and other adjustments, with a corresponding increase in accumulated other comprehensive income. The filing also reports a July 2010 redemption of affiliated structured notes with no gain or loss.

Important facts for investors to verify

Whether U.S. mortgage delinquencies, claim severity, paid claims, and reserve development continue improving, and how much of the reported benefit depends on loss mitigation or rescissions.
The adequacy and recoverability of reserves, captive-reinsurance recoveries, and reinsurance counterparties, particularly for U.S. mortgage insurance and older long-term-care policies.
The quality, valuation, and impairment sensitivity of the investment portfolio, including structured securities, unrealized losses, and Level 3 fair-value estimates.
Parent-level liquidity, subsidiary dividend capacity, debt maturities and covenant headroom, and the availability of revolving credit under stressed conditions.
The sustainability of earnings excluding the $106 separation-related tax benefit, investment gains and losses, currency effects, and other unusual or market-sensitive items.
Whether Canadian and Australian mortgage originations, European consumer lending, and U.S. housing and employment conditions develop as management anticipated.