Genworth Financial, Inc.
Q3 2012 Earnings Call Transcript

Published: 31 Oct 2012

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Genworth Financial's Third Quarter 2012 Earnings Conference Call. My name is Hewey, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. [Operator Instructions] I would now like to turn the presentation over to Georgette Nicholas, Senior Vice President of Investor Relations. Ms. Nicholas, you may proceed.

[Georgette Nicholas:]

Thank you, operator. Good morning, and thank you for joining us for Genworth's third quarter earnings call. Our press release, financial supplement and third quarter 2012 investor materials were released last evening. Earlier this morning, additional information regarding our vision and strategy was posted to our website. Today, you will hear from Marty Klein, acting Chief Executive Officer and Chief Financial Officer. Following our prepared comments, we will open the call up for a question-and-answer period. In addition to our speaker, Pat Kelleher, President and CEO of our Insurance and Wealth Management Division; Kevin Schneider, President and CEO of our Global Mortgage Insurance Division; Jerome Upton, Chief Financial Officer of our Global Mortgage Insurance Division; and Buck Stinson, President, Insurance Products for our U.S. Life Insurance segment, will be available to take your questions. With regard to forward-looking statements and the use of non-GAAP financial information, during the call this morning, we may make various forward-looking statements. Our actual results may differ materially from such statements. We advise you to read the cautionary note regarding forward-looking statements in our earnings release and the Risk Factors section of our most recent annual Form 10-K and quarterly report on Form 10-Q, each as filed with the SEC. This morning's discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. In our financial supplement and earnings release, non-GAAP measures have been reconciled to GAAP where required, in accordance with SEC rules. And finally, when we talk about International Protection and International Mortgage Insurance results, please note that all percentage changes exclude the impact of foreign exchange. And now, let me turn the call over to Marty Klein.

[Martin P. Klein:]

Thanks, Georgette, and good morning, everyone. Before we get started, I'd like to say that we wish the best for all the people who are dealing with the aftermath of Sandy. This morning, we'll provide an overview of our corporate strategy, give an update on the holding company, including our credit rating situation and review third quarter results in our businesses. In developing a strategy, our highest priority has been to rebuild value for shareholders. Working with the Board of Directors, the management team has developed and begun executing specific plans to both safeguard and maximize the value of the company for shareholders. We intend to accomplish that goal by achieving return in equity in each of our core operating businesses in excess of its related cost of capital, generating significant cash flow to the holding company from core business dividends and realizing value from our non-core businesses and enhancing financial flexibility by

[Operator:]

[Operator Instructions] Our first phone question comes from the line of Sean Dargan with Macquarie.

[Sean Dargan:]

I have a question about your targeted debt-to-total capital ratio. You mentioned the medium-term goal is 20% to 22%. That's a bit higher than, I think, the 18% to 20% you talked about last quarter. What -- how long will it take to get to that medium-term goal and what steps will you take to get there?

[Martin P. Klein:]

Sean, it's Marty. Thanks for the question. As we look at how we project out our earnings and look at the debt ladder and how it matures, we think that we'd sort of move into the 21% to 22% range in about 3 years from now. That assumes that with the $600 million maturity in 2014 that we'd only really refinance, about $250 million of that at some point in time, and the rest really comes from the delevering that happens along the way and as well as retained earnings. So it really is going to take about 3 years to get to the 21% to 22% range. Then obviously, as we generate capital from some of the things that we've talked about earlier, that would obviously give us the opportunity to accelerate that.

[Sean Dargan:]

Okay. And just one follow-up about the Australian partial IPO. I mean, what has changed to push it back another back half of the year, I guess? And what's changed in the Australian market that's led you to push back the timeframe?

[Kevin D. Schneider:]

Sean, this is Kevin. As you think about our performance down there, we feel good about a return to profitability. And the stability that we've seen, now a couple of quarters in our results. I think what continues, not so much to change, but to evolve down there, is some of the capital pressure from a regulatory capital standpoint. And basically, the regulator in this environment, as Marty mentioned in his opening remarks, the regulators are cautious in these markets right now. The other thing that I think we all need to be cognizant of is just what's going on in the overall market for IPOs in Australia. There's simply been no material IPOs of any size down in that market this year. And that's why I think there remains some uncertainly in that market regarding the stability to tap into the market from that standpoint. We do remain committed to a partial sale. I think the thing that's most changed for us though, as we think about it is, is we're going to do what it makes the most sense for our shareholders. And in our view, at this point in time, is that our valuations should improve in that market as we move towards the end of the year. Moving performance, subsequent quarters of improving performance will continue to help that, will continue to help the valuation improvement. And again, that's one we're targeting at this point because we think it will be the one that will generate the best outcome for our shareholders.

[Operator:]

Our next phone question comes from the line of Jeff Schuman, KBW.

[Jeffrey R. Schuman:]

I was wondering if you could help us just tick and tie a little bit on the holding company cash numbers. I think you said pro forma for the $375 million, it goes to the OPCOs, hope it would have about $1 billion. Then I think you said you would end the year around that level, but there would also be some dividends this quarter. So I wasn't sure if there were some uses for those dividends or how we kind of true-up that arithmetic.

[Martin P. Klein:]

Yes. Thanks for the question, Jeff. I mean, we're at right around our liquidity target at the end of the quarter, maybe just barely in excess once you adjust for that $375 million that will go down to the operating companies, mostly the life companies during the fourth quarter. But then the fourth quarter, we have a few different things moving. We do have some dividends coming in, but we also have debt service that's going up the other way. So with our projections, we kind of assume that will all land at around $1 billion by the end of the year.

[Jeffrey R. Schuman:]

Okay, that's helpful. And just one other thing, if I may. Long-term care continues to have some issues around performance to the legacy block, but there was a reserve released this quarter, which I guess, you made them for technical reasons, but it seems kind of counter-intuitive. Can you kind of help us understand the nature of the reserve released recently?

[Patrick B. Kelleher:]

This is Pat Kelleher. I'd be happy to do that. We are nearing the completion of our implementation multistage update in the reserving system. What we did complete in the third quarter was claim reserve updates. And we actually had some reserve adjustments, some components of the reserve increased like on certain facility claims. Other components of the reserve decreased because we found that the reserves were redundant. So the first thing that's important there is in that component of the changes, we found that our reserves were approximately right in aggregate, and our total claims reserve was sufficient. So it didn't change materially. We did have about $15 billion of active life reserves we're holding on that business a set of minor adjustments, which resulted in a favorable impact to earnings of $29 million after tax. And we do not expect a material impact since the remaining work is completed. We also did some work updating our GAAP loss recognition testing and our staff reserve adequacy analysis. And consistent with earlier periods, we've concluded our reserves are adequate and appropriate, so it made sense to make the technical adjustments. Does that help?

[Jeffrey R. Schuman:]

That helps a lot.

[Operator:]

Our next question comes from Geoffrey Dunn with Dowling & Partners.

[Geoffrey M. Dunn:]

I have a question on the MI side then Ryan has one on life. On the MI side, can you update us where we stand with respect to the IBNR cushion from the previous reserve charge? And then in the quarter, can you talk about the sequential decline in the reserve for loan and defaults? Was there a mix shift occurring in the payouts incurs or any detail behind that?

[Kevin D. Schneider:]

Yes, Jeff, when you -- this is Kevin. I would just tell you our overall view of the -- the reserve that we put up in the second quarter of last year that included that additional provision you're talking for with an expectation of additional losses, it's a long way away from looking at the delcs [ph]. But that -- those reserves were put up with to tell you where we're at in terms of the consumption of that total provision. I will tell you our reserves continue to hold up quite well. In the aggregate, we think we remain on track, as any pressure we've continued to experience from aging has been offset from the severity improvement we've been seeing in our actual claims. So we -- basically, we think we're on track with it and that our reserves are adequate at this point in time.

[Geoffrey M. Dunn:]

Okay. Was there any notable benefit from releases related to the curtailment activity over the last several quarters?

[Kevin D. Schneider:]

Nothing significant. It's just the ongoing curtailment benefit we're actually achieving on the individual loans, as we perfect those claims and as we process those claims. So no big release or something like that, if that was your reference.

[Geoffrey M. Dunn:]

Okay. And then Ryan has a question on the life side.

[Ryan Krueger:]

I have a couple of quick ones. What's the expected earnings impact going forward from the life block transaction?

[Patrick B. Kelleher:]

This is Pat. The impact that we would expect going forward would be that life earnings would be lower on an annual basis by about $5 million a year, it's about $1 million a quarter. And that's on a transaction that generates in excess of $100 million of capital when completed.

[Ryan Krueger:]

And then what's the regulatory capital that is held in the international protection entities?

[Patrick B. Kelleher:]

We'll look that up. My estimate would be in the $800 million to $900 million range, and we can confirm that later as we look that up.

[Ryan Krueger:]

Okay. And then just one clarification. The comment on statutory reserves, the long-term care being adequate. Does that also incorporate your expectations for year-end statutory cash flow testing?

[Patrick B. Kelleher:]

At this point in time, we've done the work relating to third quarter, and we'll update you on the fourth quarter analysis when that work is completed. And to your point on the statutory capital, as of the end of the third quarter, it's about $770 million of statutory capital in the international protection entity.

[Operator:]

Next questioner is Suneet Kamath with UBS.

[Suneet L. Kamath:]

Had a couple of questions. First, just a follow-up, I guess, on Sean's line of questioning on the debt to capital. There's the 3 years that it takes to get to the, I guess, 21% to 22%. Does that incorporate any of the strategic transactions that you're talking about, be it Australia IPO or any of these other additional life block transaction?

[Martin P. Klein:]

Suneet, no, it does not. I was attempting to clarify that, but maybe I was not successful. So we get down to that 21% to 22% range in about 3 years, with just sort of the natural progression of our debt ladder and retained earnings. And assuming that with that $600 million of debt that comes due in 2014, that we'd refinance just about $250 million of that. All of that excludes the impacts of any capital generation actions, which should give us the opportunity to accelerate that deleveraging if we chose to.

[Suneet L. Kamath:]

Got it. Yes, you might have clarified it, I just -- maybe I missed it. And then, I guess, follow-on to that, can we assume, given the priority set that you established, that probably not going to see anything material in terms of share repurchase until that leverage ratio gets to your target level?

[Martin P. Klein:]

Good question. I think that we're going to look at it at the time. Obviously, creating financial flexibility is a very important objective of ours, and deleveraging is certainly one of the ways we're going to do that. But we're also very mindful of where our shares are trading and will be trading, and we'll look at that as well, and we'll make the assessment at that time.

[Suneet L. Kamath:]

Okay. And then I guess my second question is on your presentation, you mentioned a couple of times I guess one of the challenges is the interdependence of your businesses. Can you just talk about some of the key aspects of that comment and what actions you could take to reduce those interdependencies?

[Martin P. Klein:]

Sure. We do think it's very important as we improve our business performance, as well as our financial flexibility that we manage the businesses on that kind of standalone basis that we talked about. And I think there's a few different things that we want to look at. We want to make sure that as we have goals for the businesses with respect to the returns, return on equity, particularly as we're writing new business, for example, that we look at that expected ROE when we're pricing and developing products. And we want that to be in excess of the appropriate cost of capital for that particular business line. As you can imagine, different businesses have different risk profiles, different tenures, so obviously, their cost of capital should vary -- or rather, their return on equity should vary along with that. And also, different businesses have different amounts of debt, or different amounts of leverage that they can carry. For example, a stable portfolio, life insurance businesses could really have a leverage of 22% to 25%, maybe 26%. For mortgage insurance platforms, that's a lower type of range. You're looking at probably typically around 15%, maybe as high as 18% and as low as 12%. So you've got different amounts of leverage. So we want to make sure that each of our operating businesses is being run in a way that can support its specific debt leverage, as well as an appropriate target for it. And then finally, we want to make sure that we're covering all of the expense loads in our pricing, and that there's not any kind of reliance and support from other businesses or from the holding company to do some things that aren't priced in, into our products.

[Suneet L. Kamath:]

Okay. But from a capital perspective, is there any sort of cross-subsidization of these businesses that needs to be unwound or anything like that? I get the whole standalone profitability and cost of equity idea. I think that's a good one. But just in terms of cross-subsidization of capital, is there anything that we need to think about there?

[Martin P. Klein:]

Well I just think, for example, that as we're managing our debt, we're going to be looking at it and managing our individual businesses, so they're carrying their appropriate share of debt loads. For example, as we're pricing mortgage insurance, we're going to assume that we are able to lever it at 15% number instead of an overall 25% number, which has been what we've been doing. We've been operating at a combined leverage ratio of 24% to 26%, which for a diversified set of businesses, we think is entirely appropriate. But we want to make sure for pricing and those types of returns that we're really looking at the businesses to be priced for their particular debt load that's appropriate. So in case of MI's, for example, we'd be looking to price more of the 15% leverage assumption as opposed to the 24% or 25% leverage assumption. Similarly, we want to look at -- on the other side of the coin, we look at, for example, long-term care returns. And while the overall diversified set of life businesses, you might want to have a cost of capital looking at 11% or 12%. We realize that for long-term care particularly, it's a higher number. It's been a riskier product, but we're working to change that risk profile through underwriting and pricing and product design. But we think long-term care, for example, has a cost of equity that's probably 13% to 15%, maybe even 16%. So we need to make sure that as we're pricing it, that it carries -- or it covers that particular cost of equity. Does that help you?

[Suneet L. Kamath:]

Yes.

[Operator:]

Our next questioner is Mark Palmer with BTIG.

[Mark Palmer:]

You mentioned during the strategy overview that there was the potential for new code-type options for the U.S. Mortgage Insurance unit. Could you provide some more color on what you're thinking along those lines?

[Kevin D. Schneider:]

Mark, this is Kevin. I'll provide the extent of the color that I can, given where we are in these discussions with the various stakeholders. I think the way we think about U.S. MI and what we're really trying to drive there is, number one, we're going to continue to write as much of that profitable business as we can under the waivers that have currently been granted to us by our home domiciliary state regulators, as well as the other state regulators across the country. Secondly, we have the additional potential to write business through another subsidiary that we've talked about, our GRMAC subsidiary. And we're only writing in a very narrow handful of states there right now that haven't provided the waivers. So in the next possibility you could do there is just think of that as it's got enough capital in it to write sort of 50-state-type production for about 6 to 12 months. So that's another opportunity. Then you start getting to -- I think, your real question, which is what are some of these other structural alternatives? And I'll just say that we're on ongoing discussions with our regulators, with the GSEs to consider various alternatives that we could -- really when we -- they're really in confidential in discussion right now. But as we get closer to the point that we can bring back and talk with you about them, we'll be glad to do that. One example could be an alternate use of the GRMAC entity and doing something with that structurally. So all on track, these are good potential structural alternatives for us. But really, I'd say where we start with is where -- with our current waivers, we're in good shape and be able to continue to write in the places where we were writing. The last thing I'll just add on to that is when we think about some of these new code structures or alternative structures, one of the things they might give us the ability to do is to prevent an avenue to bring in some external capital outside of Genworth in the event that, that's the alternative that we needed to be able to write the new business, and it wouldn't be reliant then at that point at our own internal capital.

[Mark Palmer:]

Okay, very good. One other question with regard to Moody's, as you mentioned the extent of the review, could you give us a better sense of where things stand with regard to Moody's? Were they waiting for a release of your strategic plan? Are they holding off until they see what happens with regard to execution of that plan? Just a general sense of where things are.

[Martin P. Klein:]

It's Marty. Let me take that one. Obviously, with the rating agencies, it's a different type of relationship, so we had the opportunity to give them a lot of detail that's not publicly available. So we spend a lot of time with the agencies, Moody's and S&P, for example, talking to them well in advance of this call about the strategic plan, as well as some of the alternatives that we're looking at in U.S. MI that Kevin was just talking about. So they've had a chance to see that. We do think that if we're making very good headwinds, strategic plan and also able to implement a number of these alternatives with regarding to the U.S. MI, they will be very, very helpful to the Moody's process. So we're working very urgently and diligently to move these things along.

[Operator:]

Our next question comes from Geoffrey Dunn with Dowling & Partners.

[Geoffrey M. Dunn:]

Kevin, can you provide some of the key macro and operational assumptions behind your projection for return to profitability in domestic MI next year?

[Kevin D. Schneider:]

Yes, Geoff. I'll hit sort of some macro assumptions, as well as just I guess point to some of the trends that we're seeing right now and how we feel about those. Back in -- when we gave sort of our expectation that we had a path to profitability back in February, we said we're going to have a burnout of the 2005 to '08 books. Well, we're seeing that. We thought we're going to have -- and that was all based upon an adequacy of our reserves. We're seeing that. It was based upon -- eventually, the referent [ph] performance of the new books of business starting to outweigh the bad books of business, and we're seeing that happen today. The market that we're seeing for mortgage insurance is coming back for us to be able to operate and participate in is in excess of what we had expected back in February at that time. Our share levels are generally holding up, so our -- the combination of that improvement in purchase penetration that's creating the bigger mortgage insurance market, the good pricing we have and the -- and our share performance is helping us. We said we were going to continue to expect loss mitigation benefits at that point. I think we'd see about $300 million and $400 million where we're coming through, and we're going to be exceeding those targets. So we feel good there. When you sort of bring it back all those things and bring them together, we're just on the glide path towards hitting that profitability as we expected back in February. We -- the last thing I think we said at that time is our overall delinquencies and new delinquencies were going to go down about 20%. We're on track. Year-to-date, it's down 23%. So all those trends are heading in the right direction. Getting back to your macro question, we're still expecting, we're going to have -- unemployment is not going to change materially from here on out. We're still going to be operating -- not much help from the growing employment base. Anything that accelerates that right now from the current level could be a good tailwind for us. But we're not expecting any material improvement in unemployment. And in fact, we expect to be sort of elevated throughout 2014. On the peak -- on the HPA basis, we think we've sort of troughed and we've hit the bottom at about a total 20% downturn from the high in the FHFA index. And we really expect that to have slow and gradual growth going forward from here, and we're starting to read more about that and hear about it more in the press today as it materializes out there. So just directionally, all our trends are really heading in the right direction. We feel good about it. The new books are about to get to that inflection point when they start to tip over the experience on the old legacy books, and we're encouraged by what we're seeing.

[Operator:]

Our next question comes from Jeff Schuman with KBW.

[Jeffrey R. Schuman:]

Can you help me better understand the nature of the Australian regulatory concern? It seems like if you do an IPO and transfer some of your shares to the public market, that doesn't directly impact the balance sheet or capital of the Australian entity. And in fact, it gives that entity sort of a new avenue to access some capital. So what kind of is the reason for their pushback on the IPO?

[Kevin D. Schneider:]

It's not really a regulator pushback on the IPO. If you just think about our regulatory capital levels that we're holding to, as you saw in the quarter, our MCR levels came down a bit from where they were in the previous quarter. We had told you that, that was going to happen after our second quarter call, largely the result of the elimination of some reinsurance, affiliate reinsurance that we had in the system that was being provided by the U.S. MI business. So one of the things we're working through is rebuilding and building that MCR back up into a level that we think will be more appropriate in that regulatory environment. And so think of that in the low end 40s to a higher maybe 150 MCR-type level. So we're doing that through the continued improvement in our business performance. We're doing it through looking at other ways of managing the capital, perhaps by the usage of some reinsurance. And so you got to -- we're working through those things with the business right now. They have implications to ultimately the ROE of the business. How much capital you hold is really driving what's the ROE of that business, what's the ROE of that business over a forecasted period of time that you could disclose. When you're doing in some type of public -- some type of IPO-type process, and that all drives valuation. So at the end of the day, it all comes back to valuation. And we just think, as I mentioned earlier, that those valuations will improve as we get deeper into 2013, allowing us to hit a higher valuation and deliver more value to our shareholders.

[Jeffrey R. Schuman:]

Okay. That's very helpful, Kevin. And I was wondering if I could ask you about long-term care, that I think you mentioned possibly looking at a reinsurance maybe of in-force long-term care. I was wondering if you could comment on market capacity there. I know there's some reinsurers who publicly said they're interested in reinsuring new business, but not so much legacy books.

[Patrick B. Kelleher:]

Yes, we certainly have a market, and we do reinsure our new business, and we're benefiting in our capital plan and our risk management plan from that. With respect to the existing business, I really think that the path to building value is proceeding with the announced rate increases and rating changes, particularly on the older book. Because if you were to look at the reinsurance support, it potentially would be a lot better after we complete those re-rating processes rather than before. So while right now, our existing business plan is looking at the re-rating processes as the means of mitigating the losses on the older book and thereby, improving profitability of the book overall. As we finish that, we will, of course, look at reinsurance markets and support and how we're using capital to support that business and as well how to produce the best valuation of the business over time for shareholders.

[Operator:]

And we do have time for one final questioner. Our final question for today's event will come from the line of Suneet Kamath with UBS.

[Suneet L. Kamath:]

Just a question on interest rates. Last week, we saw a couple of companies take some pretty sizable charges related to reducing long-term interest rate assumptions in their DAC models and I guess in their reserving. And I know you had a modest adjustment in 3Q. But just curious if you're seeing any pressure in terms of having to take an action like we've seen from other companies at some point down the road if rates remain low and if there's any way you could help dimension the size of that potential action.

[Patrick B. Kelleher:]

This is Pat, Suneet. I'll take that. The characteristics of our portfolio are important here. If you look at our Life Insurance business overall, our total liabilities on UL products are only in the neighborhood of around $7 billion, relatively -- relative to a much larger and general account balance with reserves on FAS 60-type products like long-term care and also like term life insurance. And when you look at the secondary guarantee universal life portfolio, where you'd probably be most concerned about that, those reserves are only 7% of our total UL reserves. So we did take a close look at our emerging yields. They're actually consistent with prior periods. So while there is exposure to low interest rates, we haven't really seen that impacting our core yields to date. We did make some changes in assumptions, making the projected interest rates for reserving purposes more conservative, and that's what resulted in the change. But that's why perhaps it's different for us than you've seen from some other companies in the space with much larger UL portfolios.

[Suneet L. Kamath:]

Got it. So you're not anticipating anything if rates stay low, I guess, over the next year or so in terms of...

[Patrick B. Kelleher:]

If rates stay low and consistent with our forward-looking assumptions, we think we'll be fine. If rates stay low and get worse than those assumptions, then we'll reevaluate every quarter. But again, that's a relatively small proportion of our overall portfolio from a reserving perspective.

[Martin P. Klein:]

And Suneet, I would just add that, as I mentioned in the script, that we do expect next year and the year after rates and really for us really what's more important is our investment yields to stay at the current levels that we'd expect maybe $0.01 or $0.02 of pressure over the next year or 2. Some of that over the course of really we're seeing a bit of this year and next year really comes from what's happening in Australia, which is largely a floating-rate market. So as rates there have dropped really about 1.25% roughly now from where they were at the beginning of the year, that sort of changed over that forecast. That chart that we sent out in February, so just relate down, $0.01 or $0.02, to that chart. And what we can do in the fourth quarter is really provide an updated view of where we are at that point in time going forward.

[Operator:]

Thank you, sir. And that does conclude Genworth's Financial Third Quarter Earnings Conference Call. Thank you for your participation. At this time, this will end the call.