Genworth Financial, Inc.
Q4 2012 Earnings Call Transcript

Published: 6 Feb 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Genworth Financial's Fourth Quarter 2012 Earnings Conference Call. My name is Shannon, and I will be your coordinator 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 today for Genworth's Fourth Quarter 2012 Earnings Call. Our press release, financial supplement and fourth quarter 2012 investor materials were released last evening. And this morning, additional information regarding our 2013 business goals was posted to our website. We encourage you to review all these materials. I would like to note that we have changed the financial presentation for divisions to align with the strategy announced in October 2012. We will now operate through 3 divisions

[Thomas Joseph McInerney:]

Thanks, Georgette, and good morning, everyone. Let me first say I'm very excited to be joining you today for my first Genworth earnings call. Having just joined the company about 1 month ago, I've been spending most of my time getting to know Genworth, its products and businesses and the management teams in each of the businesses. I am looking forward to working with the board and senior leadership to execute the strategy announced recently. This morning, I want to briefly cover 4 points

[Martin P. Klein:]

Thanks, Tom, and good morning, everyone. Today, I'll provide an overview of results for the quarter. As we move into a new year, I'll also talk about our financial goals for 2013, as well as discuss how we did on our 2012 goals. Let's begin with fourth quarter results. We reported operating income of $167 million for the quarter and net income of $166 million. The results included $78 million favorable adjustment from the finalization of a new government guarantee framework in Canada. Overall in our businesses, we saw a generally stable performance in Global Mortgage Insurance and mixed results in U.S. Life. In Global Mortgage Insurance, excluding the $78 million adjustment for Canada, net operating income was $53 million compared to income of $56 million in the prior quarter. Let's discuss Canada first, where our operating earnings were $36 million for the quarter when excluding the $78 million adjustment. Unemployment improved slightly sequentially, and home prices were flat to the prior quarter. The loss ratio increased 1 point sequentially to 31%, while improvement in the Alberta region continues. Changes put into effect in July to the eligibility rules for government guarantee mortgages reduced the size of the high loan-to-value mortgage insurance market and, along with normal seasonal impact, drove our NIW in the quarter down 40%. We did complete several bulk transactions in the quarter of approximately $4.1 billion. We participate selectively in this market, and these transactions consist of low loan-to-value prime loans. As I mentioned earlier, our results included $78 million this quarter from a new Canadian government guarantee framework, which took effect on January 1, 2013. While there's no change in the 90% level of the government guarantee to the business under the new legislation, it does eliminate the government guarantee fund, along with its related exit fees, in favor of a higher regulatory capital target set by Canada's Minister of Finance. The elimination of the government guarantee fund will increase the business's regulatory capital available, but that increase is expected to be predominantly offset by an increase in its required capital. Our capital positions remain solid in Canada. Turning to Australia, operating earnings were $62 million versus $57 million in the prior quarter. Unemployment was down slightly, and home prices were down about 1%. While lower interest rates have improved affordability, consumers are still cautious. The loss ratio for the quarter dropped significantly to 36%, down 11 points sequentially. Overall, delinquencies were down 14%, with new delinquencies improvement across all major states. While paid claims remain elevated, reserves continue to be largely in line with the trends we had anticipated when we implemented the first quarter reserve strengthening. During the quarter, we further expanded our reinsurance coverage, adding a total of AUD 350 million of external reinsurance for the year. Many of you know about the January floods in Queensland, which are not anticipated to be as bad as the floods of 2011. While we do not cover property damage caused by the flooding, if it has an economic impact on the area, we could see a new delinquency development, as we did after the last flood. We will continue to assess the impact and provide updates as the situation develops. Currently, we estimate less than 1% of our portfolio is in the affected areas or $300 million in effective risk in force. Also, earlier this week, Moody's downgraded the mortgage insurance industry in Australia and reduced our rating 2 notches to A3. We do not expect this to impact us significantly given our customer relationships, as well as the impact on the industry ratings overall. Moving to the other countries in International Mortgage Insurance segment, the operating loss is up sequentially to $11 million, driven by losses primarily in Ireland. Slow growth in 2013 is expected in the Canadian and Australian markets, where unemployment and home prices are stable. A moderate decline in the high loan-to-value markets and the seasoning of older vintages will pressure revenue but generate capital. Dividends for the segments in 2013 are expected in the range of $150 million to $200 million, while we maintain capital targets, which currently are in excess of 190% for Canada and 135% for Australia. These capital targets are dynamic and based on several considerations, such as the economic environment, business performance and ratings. We maintain prudent buffers above regulatory requirements for the possibility of unforeseen events or weaker-than-expected performance. Other International MI is expected to generate operating losses in the range of $30 million to $40 million during 2013 as pressure in Ireland continues. In January, we contributed $21 million in additional capital to the European Mortgage Insurance business, in line with our expectations laid out last February. We do not currently anticipate the need for additional contributions to the business this year but may do so if experience deteriorates more than expected. Executing a partial sale of our Australia MI platform remains a key goal. But given our liquidity at the holding company and the other levers we have to generate cash and capital, we want to execute a transaction where it makes the most sense for shareholders. Execution of an IPO is subject to market valuation and regulatory considerations, and we continue to not expect an IPO to occur until the fourth quarter of this year or later. Moving now to U.S. MI, we had net operating loss of $34 million in the quarter, slightly improved over the prior quarter from favorable taxes. We are seeing a slow recovery in the housing market, along with strong growth driven by a larger mortgage origination market and higher mortgage insurance purchase and refinance penetration in the quarter. For the full year 2012, the origination market is up approximately 24%, and overall mortgage insurance penetration is up about 2.5 points. Total losses were up slightly from the third quarter as lower loss mitigation savings and modest changes in aging were offset by lower new delinquency development with a favorable mix. Our total flow delinquencies fell by 21% from the prior year, with new delinquencies down 4% sequentially and down 23% year-over-year, reflecting the continued burn-through of the 2005 to 2008 books, as well as the new better-performing books becoming a larger portion of our overall portfolio. Last month, we announced the comprehensive capital plan for our U.S. Mortgage Insurance business. The plan reduces Genworth Mortgage Insurance Corporation's, or GMICO's, risk to capital levels and, along with our continued GMICO waivers and use of Genworth Residential Mortgage Assurance Corporation, or GRMAC, insures our continued ability to write profitable new business and generate additional capital. The plan not only greatly decreases the likelihood that the U.S. Mortgage Insurance subsidiaries will require additional capital for the foreseeable future, it also removes those subsidiaries from the companies covered by our senior notes indenture. As part of this capital plan, effective January 31, 2013, we completed the transfer of ownership of the European Mortgage Insurance subsidiaries to GMICO. Given the effect of this transaction, the U.S. MI risk-to-capital ratios should decrease by approximately 12 points. We expect to complete the legal entity reorganization during the second quarter, subject to various regulatory approvals. Our expectations of performance for this business in 2013 are based on the continuing improved trends in the U.S. housing market, and we remain focused on executing loss mitigation strategies, maintaining our distribution network and writing profitable new business. For 2013, we expect loss mitigation savings to be between $250 million and $350 million, new insurance written to be between $15 billion and $20 billion and new delinquency to decline between 15% and 20%. There are, of course, various possible outcomes of performance, depending on new delinquency development, cures, modifications and levels of new insurance written. Assuming no significant deterioration in the U.S. housing market or material global economic downturns, we continue to believe these trends enable the ongoing improvement in earnings for U.S. MI, with the potential return to breakeven or modest profitability in 1 or 2 quarters of this year. We expect overall performance for this year to be much improved over 2012 given that 2009 and forward books of business are expected to comprise 40% to 45% of the risk in force by the end of the year. Moving to the U.S. Life Insurance Division, reported operating earnings were $76 million. Life Insurance earnings were $49 million for the quarter. We saw significantly improved term life mortality experience in the quarter, which is also better than pricing assumptions following 3 straight quarters where mortality has been elevated. Life Insurance sales were down sequentially and year-over-year, consistent with the pricing and product actions taken this year as we managed sales volume and improved its statutory performance. In October, we introduced a term product that replaced the term universal life insurance product, and we are redesigning certain universal life insurance products and repricing others. We completed our second life block transaction in the fourth quarter, with a capital benefit of about $175 million. This benefit was larger than initially estimated due to refined estimates of the associated tax benefits. With the completion of this transaction, our life block deals have generated approximately $345 million of benefit to unassigned surplus. We will look opportunistically for such transactions going forward. Long-term care earnings of $7 million were down for the quarter. Two factors hurt results for this quarter

[Operator:]

[Operator Instructions] Our first question is from Sean Dargan of Macquarie.

[Sean Dargan:]

My -- I have 2 questions. My first question is about long-term care. Given the reserve refinement and the reserve build reflecting new assumptions, it sounds like there have been a change in assumptions. Why was that not reflected in a debt charge?

[Patrick B. Kelleher:]

This is Pat Kelleher. I'll take that. When you look at our reserves in long-term care, about 15% of the reserves or 50 -- or rather, sorry, $3 billion is our reserve for current open claims. And what we did in the third quarter of last year was we updated all of our experience studies and made adjustments, which in total were not material to the claims reserve balance reflecting our experience. Then in the current quarter, we looked at the relatively stable portfolio yields we have seen but anticipating some modest declines in the low -- in the current interest rate environment, we made a modest negative adjustment, reducing the interest rate that's used in the calculation of those reserves. So since it's a current claims or FAS 5 [ph] reserve, and it had just an impact in the current period, and we've taken into account all the costs of the currently open claims in future periods, it really had no impact.

[Sean Dargan:]

Okay. And shifting to U.S. MI, how do we get from a loss of $26 million this quarter to breakeven or modestly profitable quarter? I mean, what quarter should we be thinking about, and how would we make that jump?

[Kevin D. Schneider:]

Sean, this is Kevin. I think we need to start with just a little bit of a caveat that speaks to -- there's a range of possible outcomes that could occur based on the continued uncertainty in the macroeconomic environment. So -- but with that said, if you go back to the trends that we identified really last February, when we begin talking about the improving performance and our expectations for this business, our trends largely remain in line with those expectations and continue to head towards the potential for really significant improvement in the overall U.S. MI earnings and a potential again for breakeven or a modest profitability in 1 or 2 quarters. When I start to more directly ask your -- address your timing question, I think about it this way. First off, we do have the benefit of seasonality in this business. And taking account the usual trends when -- in the seasonality delinquencies and cures, you could expect that, that would point towards that breakeven or return to profitability sometime in the first half of the year, either Q1 or Q2. At the same time we also have another dynamic that continues to play through our portfolio, and that is as the older books, the unprofitable legacy books of business, continue to burn out and the further you get into the year in that burnout dynamic, adding to that the benefit we continue to realize of incremental new well-priced and highly performing production, you get to a tipping point that conceivably could be more in the later part of the year, Q3 or Q4. So it's really -- and we're not going to do a pick-point right now, but that's really, I think, the dynamics that are at play. Continued burn-off of the books, continued addition of new profitable production, getting to a point, as I think Marty identified in the goals, where you could be at 40% to 45% range of new -- profitable new books of business in the overall portfolio, that starts to drive that tipping point later on in the year. And then lastly, just as an additional item and it doesn't really help in nailing down your question, but we also do benefit from some dividends from affiliate investments we have in our portfolio. And those come in Q1 and Q3, so again, could help drive it in the first quarter, it could also help drive it potentially in the latter part of the year.

[Operator:]

Our next question is from Mark Palmer of BTIG.

[Mark Palmer:]

Quick follow-up question on Australia. You mentioned in your comments that the flooding this year, at least the impact of the flooding, is not as bad as it had been in 2011. And I believe you said that it would impact an estimated less than 1% of the portfolio. Last year, as I recall, the issue really stemmed from one lender in particular. I want to get a sense of, with regard to the exposure in question, what the composition of that might be. Is it one lender, is it more than one lender, what more can you tell us about that?

[Thomas Joseph McInerney:]

Yes, Mark, first of all, just let me revisit Marty's directional comments on it. We -- our early assessment, it's going to be low to modest impact. When I -- when you look back on last year, the current flooding, compared to what we experienced in 2011, in Queensland is far smaller. It's really primarily isolated in the rural areas. Again, our master policy really specifically excludes physical damage, including floods. I mean, so when we talk about this range of output, we said it's really primarily linked to the economic impact to the environment. Stepping back from that, related to your question, it's really spread over all of the lenders that we have that we've done business in that area. It's not specifically just identified to one lender. We do have some lenders we do more business with than others. But at again, at this point in time, early assessment, still early, we'll update you as we continue to see the trend's development, but we expect a low to modest impact.

[Mark Palmer:]

Okay. And one other question. With regard to the U.S. Mortgage Insurance business, we've seen the U.S. government pulling back from the mortgage insurance space or at least announcing that they intend to pull back. To what extent are you seeing that pullback translate into increased opportunities to write new business?

[Thomas Joseph McInerney:]

Yes, great question. And when you talk about the U.S. government, I'll specifically highlight we're talking about the FHA, which is the government's mortgage insurance arm. And just from a trend perspective, if you look at the way our penetration, which is mortgage insurance penetration, into the market has developed over the years -- or excuse me, over the year, we're really coming out of 2012 at a fairly high penetration rate, 8% overall. That's starting from a point going into the year that was about 5%. Our refinance penetration, which is usually lower than our purchase penetration, has almost doubled over the year as we've gone into the year. And our purchase penetration, which is really the bread and butter of our business, exited the year as an industry at almost 17%, sort of back to pre-go-go year type levels is the way I'd characterize it, sort of 2002 or 2003. So you see the government raising prices on the FHA's business. You see them getting more restrictive in terms of their underwriting policies, and that business is beginning to flow back into our markets. We hear it from our customers. You can see it in our production, even with sort of stabled share growth this quarter, my production was up on a BPQ [ph] basis about 9%. And then you compare that to where we were on a prior year basis, we're up over 50%. So the market is getting bigger, it's a market we think is an attractive market to play in, and we continue to be very disciplined in our pricing approach to going after that business.

[Operator:]

Our next question is from Geoffrey Dunn of Dowling & Partners.

[Geoffrey M. Dunn:]

A couple questions. First, on the MI side, can you qualify your '13 expectations for new default development with some commentary on how you think shares are going to trend? Because at the end of the day, kind of that change doesn't overly matter without kind of the impact on net new notices. So what you think cures are going to do relative to that 15% decline?

[Thomas Joseph McInerney:]

We gave you a range, I think, in -- of 15% to 20% new delinquency decline next year. That would -- that is a range that we think the overall business will perform within. We did a similar thing this year, targeting about a 20% decline, and that played out, I think, close to 23%. New -- as it relates to modifications and cures, I think they're going to go down. Directionally, they're going down. Number one, we have less inventory to deal with. And so you just -- just based upon the amount of inventory, delinquent inventory we have, it should go down. But as we continue to see some improvement in overall economic development, I think that's going to continue to help that as more jobs that will help with this healthcare line. So at the end of the day, I think although modifications will be down, they will be down and will continue to help support the overall new delinquency development, which we also think is going to be down. I think the trends are -- we don't expect any major falloff, Geoff, in our overall cure expectations. And it's really -- it's in line with the way we think about our overall reserves and the way we have them set.

[Geoffrey M. Dunn:]

Okay. Also, the risk to capital this quarter, you only saw about a 0.6 increase sequentially. Outside of some modest realized gains in the P&L, were there any other balance sheet adjustments which aided that ratio this quarter?

[Thomas Joseph McInerney:]

Well, we got some -- a little bit of benefit from some deferred tax asset realization. And so that comes through the stat line, gives us a little bit of help there. And you mentioned that we did have some modest gains in terms of the overall portfolio, but nothing else, no other major drivers.

[Geoffrey M. Dunn:]

Okay. And then starting the long-term care side, a couple questions Ryan asked me to pass on, related to the year-end, did you have any stat reserves as a result of your cash flow testing?

[Patrick B. Kelleher:]

Yes. This is Pat, I'll take that. On long-term care, we've done a thorough review, loss recognition testing, and we're comfortable with the results there in terms of our provisions being adequate. We have completed the -- of course, the Q3 stat loss recognition testing. We're finishing up the process in Q4. And from my standpoint, where we are currently, we're comfortable that our reserves are adequate and that our capital position is strong and as stated.

[Geoffrey M. Dunn:]

Okay. And his other question was, you gave the income statement impact from the low interest rate environment. Would you anticipate any kind of GAAP or stat balance sheet impacts from the same analysis?

[Patrick B. Kelleher:]

In doing the work relating to loss recognition and cash flow testing, we're taking into account all of our experience, and we've reflected on the reserves where they should be on our balance sheet. I would say just to kind of add a little bit of clarity to the performance as we go forward, if I look at the quarterly performance over the last couple of years, I would say that we've had pretax margins on the long-term care business between 5% and 10% of premiums; some quarters larger, this quarter a little bit less. But on an annual run rate basis, the earnings level has been a little bit more stable, around $100 million in each of the last 2 years. And the important thing to recognize in terms of what Marty announced before in terms of the rate actions, on $2 billion worth of in-force annual premium, we're expecting at this point to get about $200 million to $300 million of additional premium through those rate actions over time, with only I guess 20% of it actually realized to-date based on approvals that we've got. When we look at the impact of that on our statements over time, it's probably important to recognize from a process perspective, the rate increases are implemented after notice on the next policyholder anniversary. So we're only seeing a portion of the approvals that we've gotten already and over the course of 2013, with the rest recognized in 2014. And given the size of these rate increases, we're offering a range of options that allow policyholders to elect to reduce benefit options. I'd say overall, most of the policyholders, it's been our experience that they would go along and pay the rate increase. Although this time, since it's larger, we would probably see more policyholders electing reduced benefits. So as a result, we'll see those increases coming into our results and strengthen our earnings on our balance sheet over time, with about $20 million to $30 million, as Marty said, of the impact being felt in the current year.

[Martin P. Klein:]

I would just add, Geoff -- it's Marty -- that as we show in the analysis on the impact of lower rates, that analysis is really just the impact on after-tax net spreads and does not include the impact of any DAC or reserve unlocks, which is a little bit harder and more speculative thing to model in this type of analysis given the number of factors involved.

[Operator:]

Our next question is from Tom Gallagher of Crédit Suisse.

[David Motemaden:]

This is David Motemaden asking on behalf of Tom Gallagher. I see on Page 5 of the slide deck that you guys put out that stat earnings were $275 million for the year. Could you tease out how much of that is due to the life block transactions and the tax gains or the tax benefits that you had?

[Patrick B. Kelleher:]

This is Pat, I'll take that. The stat earnings that we report on Page 5, I believe, are the Genworth Life Insurance companies' statutory earnings, which are really the earnings of the parent company and the group that generate the dividend capacity to the holding company. If you look at the stat earnings of I'll say all of the entities in the group, it would certainly have been larger than that in the current period. The one thing that I would say is, from the life block transaction perspective, we have a capital benefit of $175 million, but a significant portion of our capital benefits are not actually from the statutory earnings. So it would only be a portion of that, that would be reflected in the earnings of the U.S. entities. Does that help?

[David Motemaden:]

Yes. And then I think you guys had mentioned that you expected lower tax benefits in 2013. Just wondering how much that impacted 2012.

[Patrick B. Kelleher:]

To give you an -- I can give you a general idea. When we did the life block transactions and the work that we did to generate and bring capital onto the statutory balance sheet, we were able to, through those transactions and our other operating results, utilize some previously non-admitted tax loss carry forwards in the statutory balance sheets. And when those are filed you can -- on our precise number, but you can look at those and see how that position changed, and that generally was directly accretive to our capital position and was part of our intended result.

[Operator:]

Thank you. There being no further question, this will conclude Genworth's Fourth Quarter 2012 Earnings Call. Thank you for your participation. At this time, the call will end.