Genworth Financial, Inc.
Q4 2013 Earnings Call Transcript

Published: 5 Feb 2014

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Genworth Financial Fourth Quarter 2013 Earnings Conference Call. My name is Catherine, and I will be your coordinator for today. [Operator Instructions] As a reminder, the 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, and good morning, everyone. Thank you for joining us for Genworth's Fourth Quarter 2013 Earnings Call. Our press release and financial supplement were released last evening, and this morning, our fourth quarter earnings summary presentation, along with additional information regarding our 2014 business goals, were posted to our website. We encourage you to review all these additional materials. Today, you will hear from our President and Chief Executive Officer, Tom McInerney; followed by Marty Klein, our Chief Financial Officer. Following our prepared comments, we will open the call up for a question-and-answer period. In addition to our speakers, Kevin Schneider, President and CEO of our Global Mortgage Insurance Division; Jerome Upton, Chief Financial Officer of our Global Mortgage Insurance Division; Amy Corbin, Chief Financial Officer of our U.S. Life Insurance Division; and Dan Sheehan, Chief Investment Officer, 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 of our most recent annual report on Form 10-K and our Form 10-Q that's 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, earnings release and investor materials, non-GAAP measures have been reconciled to GAAP, where required, in accordance with SEC rules. Also, when we talk about International Protection and International Mortgage Insurance results, please note that all percentage changes exclude the impact of foreign exchange. And finally, references to statutory results are estimates for the quarter due to the timing of the filing of the statutory statements. And now, I'll turn the call over to our CEO, Tom McInerney.

[Thomas Joseph McInerney:]

Thanks, Georgette, and good morning, everyone. Thank you for joining us today for our fourth quarter earnings call. Today, I would like to cover 3 areas

[Martin P. Klein:]

Thank you, Tom, and good morning, everyone. Today, I'll give an overview of results for the quarter and provide a recap of our 2013 goals, as well as some perspectives on our 2014 earnings drivers and goals. I'll be referencing our associated fourth quarter earnings summary and 2014 business goals and priorities presentations, which were posted on our website this morning. Let's begin with fourth quarter results, starting with Slide 3 and 4 of the earnings summary. We reported operating income of $193 million for the quarter and net income of $208 million. Net operating income is up 20% versus the prior year and 39% sequentially. We saw increasing benefits from the long-term care rate action, continuing the strong loss performance on Australia and Canada, and a profitable quarter in U.S. MI on lower losses. The results also reflect $29 million of benefits related to several tax-related items. Turning to Slide 5, in Global Mortgage Insurance, reported net income was $107 million, up $20 million from the prior quarter. Let's cover Canada results first, on Slide 6, where operating earnings were $44 million for the quarter. Unemployment in Canada at the end of December was 7.2%, up from 6.9% in the prior quarter, and there was a modest sequential increase in home prices. Premiums were down slightly from the maturing of the larger 2007 and 2008 books of business. Flow NIW in the quarter decreased 17% sequentially and NIW from bulk transactions declined as well. Overall, NIW for the year benefited from a larger origination market compared to last year, as well several bulk transactions. The loss ratio remains low at 22%. Turning to Slide 7, operating earnings in Australia were $66 million. Unemployment in the country was up slightly to 5.8%, and home prices rose modestly from the prior quarter. Taxes were favorable in the quarter, but unfavorable foreign exchange impacted the business by approximately $6 million versus the prior year. Excluding the impact of foreign exchange, premiums are up from the prior year, as the larger, more recent books mature and more premiums recognized. The continued low interest rate environment drove growth in the origination market from the prior quarter, with flow NIW up 11%. The loss ratio for the quarter decreased by 10 points sequentially to 21%, and the full year loss of 34% is better than our expected range. Regarding other countries in the International Mortgage Insurance segment, the operating loss in the quarter was $9 million. The business executed 2 lender settlements in Ireland that reduced the outstanding risk enforced in that country by almost half. Moving to U.S. MI on Slide 8, the business had its third profitable quarter in 2013, with net operating income of $6 million and a profit of $37 million for the full year. NIW slowed during the quarter from a seasonally smaller origination market, while we continued to see improvement in private mortgage insurance penetration. Our total flow delinquencies fell by 26% and new flow delinquencies dropped 21% year-over-year. The new better-performing books from 2009 forward are 44% of risk in force, in line with our earlier estimates of 40% to 45%. Full year loss mitigation savings were $563 million, well above our full year target of $250 million to $350 million, as flow modifications remains strong. Turning to capital in the division on Page 9, the MCT in Canada was approximately 222% compared to our minimum target of 190%, and the business continues to evaluate opportunities to optimize capital. For Australia, the prescribed capital amount, or PCA, was 148%, up from the prior quarter from continuing strong statutory income and execution of external reinsurance transactions. In January, the business terminated an affiliate reinsurance treaty, which should decrease the PCA going forward by about 6 points. In U.S. MI, at quarter end, the risk-to-capital ratio for GMICO was approximately 19.3

[Operator:]

[Operator Instructions] Our first question will come from Steven Schwartz of Raymond James & Associates.

[Steven D. Schwartz:]

Marty, you're going a little fast. Could you repeat the effect you thought that the LTC premium increase would have on earnings. I could not get that.

[Martin P. Klein:]

Yes. And we had a lot to cover this morning so I was talking pretty quickly. But we expect in 2014 for the impact on GAAP operating income after tax to be in the neighborhood of $120 million to $150 million. That's a combination of additional premium from the rate actions, as well as reserve releases from reduced benefits.

[Steven D. Schwartz:]

And okay, great. And that was part and parcel of an entire increase in the life, in the total consolidated life insurance business of 5% to 10%?

[Martin P. Klein:]

Yes, that's part of the overall, exactly. We expect overall division to be up 5% to 10%, really, largely driven by the long-term care performance.

[Steven D. Schwartz:]

Okay, great. And then on kind of your longer-term guidance, the ROE goes to 7% to 9%. I take it that, that does not include, really, any capital deployment. If there is capital deployment, that could be additive to those numbers?

[Thomas Joseph McInerney:]

I think, Steven, that those numbers do not assume the IPO of Australia and also don't assume any significant capital management, other than what Marty covered in the 2014 drivers and estimates. So those would be the returns based on improvement in the operating performance, driven by 2 keys areas

[Operator:]

And next, we'll move to Sean Dargan of Macquarie.

[Sean Dargan:]

I wanted to follow up on something Marty said about the December debt offering being the most efficient way to, I think, fund potential capital needs in U.S. MI. I mean, just I can't remember offhand what the coupon was on that, but given that a competitor made extensive use of reinsurance on legacy business, including some pre-2009 business, and that competitor basically said it came in at de minimis cost. I'm just wondering what the -- how you view the trade-off between adding to your leverage versus making a more extensive use of reinsurance.

[Thomas Joseph McInerney:]

Sure, Sean. We did look at a lot of different potential ways to raise capital. It ultimately felt like for us, and again, recognize that Genworth is a different company than some others with the mix of business and different balance sheet. We felt, for us, that the cheapest cost to capital, and we felt like we did have some headroom, was to do a debt transaction to really fund the capital need. We've looked at a variety of other options. Obviously, Australia IPO proceeds, if we would have them at the time would've been an option, but obviously, we done the IPO yet. We also have looked extensively at reinsurance and continue to look at it, and we do think there's some potential there. I don't think, for us, that may be as attractive a cost to capital but it's something we would be very interested in, in looking at and have been looking at it closely.

[Kevin D. Schneider:]

Sean, this is Kevin. Just add to it a little bit, the $400 million range that we raised, we think we're pretty well positioned for a variety of outcomes that could come from the GSEs. And it's important, I think, to recognize that as these requirements are phased in over time, and we certainly don't have clarity on them yet, we do have the ability to continue to benefit from the utilization of part of our remaining deferred tax assets over time. So that's going to be another source of capital for us. Our growth and earnings will be a nice positive source of capital for us. And reinsurance could always be an important tool and one that could be used. But at the same time, as we look at it today, we kind of like the earnings power of those books. And so at this point, we feel comfortable where we are. But we have multiple levers, as Marty said, once we finally get the ultimate outcome on those eligibility requirements.

[Martin P. Klein:]

And I would just add, we have had and continue to have a medium-term target of 20% to 22%, and we felt like we had the room to do it in [indiscernible] $400 million in December and still get to that timetable over the next 3 years, getting in 20% to 22% leverage.

[Sean Dargan:]

And just a follow-on about Australia. I think the customer appetite for continued use of lender's mortgage insurance as reference. Last quarter, there was some discussion about the impact of Basel II, I guess, and whether the Australian banks would continue to receive capital credit for utilizing LMI on high-LTV loans. Has there been any movement or clarity around where that 's going to shake out?

[Kevin D. Schneider:]

Yes, Sean, Basel III isn't going to get resolved in 2014. I don't think it's out there. The issue, as you accurately characterized is it doesn't currently give explicit capital relief for the major banks or the IRB banks in the market. So as they look through and consider their own modeling response to Basel III, and we support and work with them on all that. There is some evaluation going on in the amount of lender mortgage insurance that gets used in the market. As you recall, that market, there's really about 4 banks that generate significant amount of all the originations that get down to market. And it's also the only market where we have sort of contractual relationships with our clients. So I think the resolution that you're referring to is we're trying to shore up some of those contacts and we think that will put us in a better position as we look forward to potentially executing the IPO. And we'd like to get that done in the first half of the year, as suggested by Marty. And we remain very comfortable with the current momentum and the progress and results of that business line.

[Operator:]

And next, we have Suneet Kamath of UBS.

[Suneet L. Kamath:]

Just a follow-up question to Steven's to start. In terms of the incremental earnings in long-term care from the price actions, that $120 million to $150 million benefit that you expect next year, does that include what you're already receiving in terms of the benefit in 2013? Or is that incremental to what you guys are getting this year -- last year?

[Thomas Joseph McInerney:]

So Suneet, I think the way you should look at it is it's cumulative, because these increases get rolled in over time and continue. So in 2013, the total between premium increases and the reserve benefit from reduced benefit options was around $75 million. And so for 2014, our estimate is between $120 million and $150 million. So a significant improvement in '14 over '13, based on that cumulative effect, which will continue beyond '14 going forward.

[Suneet L. Kamath:]

Got it. Okay. And then, I guess, just on the Australia partial IPO. I guess, given some of the actions that you guys have taken in terms of the balance sheet and debt maturities, risk to capital in U.S. MI, it seems like you sort of ticked off on some of the palls on the proceeds from that deal, had you done it. So as we think about you, perhaps, doing this deal in the first half of this year, as Kevin, I think, just suggested, what would be the priorities for use of the proceeds? And could they possibly include capital return to shareholders?

[Thomas Joseph McInerney:]

I think that we certainly have as a strategic priority to do, we have IPO in 2014, based on all the things that we've been talking about. We don't have it in our capital plans, so it gives us the luxury of deciding to execute it when we think it's best for shareholders. In terms of use of proceeds, clearly, we have an ongoing priority to reduce our leverage further, and Marty talked about that and gave you guidance on where we'd like to be. Depending on the size of the IPO, where we are overall, we'll look at other uses of proceeds, which could include capital management, either dividends or share repurchase over time. But the priority of use of proceeds will be to reduce leverage further.

[Suneet L. Kamath:]

Okay, got it. And then just the last sort of numbers question. On Page 17 of your outlook presentation, you talked about this minimum adjusted interest coverage ratio of 6x. I just want to get a sense of where we are today in terms of that ratio. I don't know if it's something that you provide, because I think it's based on a Moody's calculation. And kind of what it would take to get to the 6x, if you're not already there?

[Martin P. Klein:]

Yes, let me field that. It's Marty. We do want to get to a minimum, over the next 3 years, of 6x. We think that is consistent with getting a 1-notch upgrade, which is also a goal for us in U.S. life and for the holding company. We think we want to be kind of to get to that next notch up, that measure needs to be kind of 5 to, say, 7x. So getting 6x gets us comfortably into that range. We are, right now, year-end 2013 right around 4, maybe just shy of 4, about 3.9x. We haven't disclosed that. We'll do so. Put them into some of our materials to give you a sense as to where we are. The lift in that, over the next 3 years, is going to come from a combination of really taking down 2014 debt and not increasing our debt load further, as well as our expected improvement in earnings, amongst some of the levers that we might have.

[Suneet L. Kamath:]

Do you have a pro forma for the 2014 debt payment? Is it 3.9?

[Martin P. Klein:]

Yes, not that we have disclosed.

[Operator:]

And next, we'll move to Ryan Krueger of Dowling & Partners.

[Ryan Krueger:]

On the ROE goal for the U.S. Life Insurance Division, you mentioned that a lot of the upside was driven by improvement in long-term care. Just wondering, in terms of the individual life business, do you think you -- is there anything you can do over the next few years to help improve the ROE on the in force business there? And is that being contemplated in the outlook?

[Kevin D. Schneider:]

We are, Ryan, just like we did in long-term care, we're taking a full look at our individual life product line. I think that from a new product perspective, we want to continue to focus on new and innovative universal life index, universal life products balancing UL or permanent with term, so say, in the range of 50-50. We also are looking at our in force business and all the opportunities to improve both statutory and GAAP results. And some of the transactions we did in 2013 are examples of that. So I do think there are opportunities on the in force and that will be one of the priorities for Jim Boyle as he comes in, to take a look at that. As you probably know, he's got a lot of experience there. So I think we'll do a full look at the individual life portfolio, and I'm sure we can find opportunities to improve the in force block.

[Ryan Krueger:]

And then on the long-term care business, the remaining delta between the $200 million of currently approved rate increases and the $250 million to $300 million target, how much of that relates to the United States that you haven't got approvals from yet? And how much relates to additional increases from some states where you've already got partial approvals?

[Kevin D. Schneider:]

So Ryan, I would say to you and all of the investors, you should go back to our December 4 presentation. We laid out on a slide there where we were at the end of the third quarter, which was $155 million to $160 million. And we showed you where the incremental amount would come for, both from the additional states plus going back to states where we didn't get the full amount. And I think we're pretty much on track with what we laid out there. So I think the best information for you would be to go back and look at that slide in the December 14 -- December 4 presentation.

[Operator:]

And ladies and gentlemen, we have time for one final question, and that will be from Brian Schinderle from BAM.

[Brian Schinderle:]

Most of my questions have been answered. I am curious, on the third quarter conference call, there was some discussion with respect to the potential Australian IPO. And I believe at the time you mentioned a regulatory change that was coming through on Australia that would help clear the runway for a potential sale. And I believe that there was some timing related to that, where you needed to get that done and out-of-the-way prior to feeling better about the timing. Can you update us on that?

[Kevin D. Schneider:]

Brian, this is Kevin Schneider. Just, as I mentioned earlier, the key regulatory issue in the market is getting regulatory approval, there's really 2

[Brian Schinderle:]

Got it. And one other quick one on the U.S. MI business. There had been some discussion, possibly a couple quarters back, thinking forward about some of the potential options for that business, including eventually looking at spinning that out, et cetera, as it returned to profitability, and as you looked at sort of all the alternatives on the table to manage the balance sheet. Just curious if there have been any other thoughts on that? Or if you still view it as an option but further down the road? Or how that would come into your thinking?

[Kevin D. Schneider:]

Yes, I would say, in the first year I've been here, I've gotten a lot of input on what to do with U.S. MI. I will credit the senior team before I got here with resisting that pressure because they do think what we've seen is a tremendous turnaround in U.S. MI. I think our U.S. Mortgage Insurance business is one of the best business we have in terms of what we're writing today. As you know, we have been achieving returns well in excess of our cost to capital in the mid to high teens. So I think it's a great business. We continue to look to improve it and I think you'll see that. I think it will be a key driver for Genworth's results over the next 2 or 3 years. And worry later on, once we get U.S. MI to where it should be, as the 2009 and '13 and '14 books become the dominant part of that book of business. But at this point, I think it's one the best businesses that we have.

[Brian Schinderle:]

Are you seeing, on the competitive side, obviously, there's been some new entrants and some renewed activity on the U.S. -- on the U.S. business for mortgage insurance. How are you finding the competitive environment? And is there any pressure on or the expectations of pressure on margins because of the competitive overlay.

[Kevin D. Schneider:]

Yes, I'll wrap up this question, Brian. Because I do think we're about running out of time here. But number one, we do feel like it's a good message to the market that there is private capital in coming into this space. Mortgage Insurance provided what its role throughout the crisis and we think that will help us even further as we try and secure the housing finance reform and regulatory outcomes going forward. We do have more competition, we're sort of at the level we started, before we started this -- before we went through this crises. We lost a few, and we picked up a few. We don't see, at this point in time, that it's going have any significant near-term margin pressure on us. We think we have a strong value proposition as we sell against our competitors. We think pricing is relatively stabilized in the market at this point. And well, hopefully, as folks are pricing at the appropriate levels for the risk we're taking. So we're excited about the future. We feel we're going to do pretty well for ourselves in 2014, and we'll get our fair share of the business.

[Martin P. Klein:]

It's Marty, and I just want to go back for a second to the Australia IPO, just clarify some of the timing. I think that, as Kevin talked about, there are 2 windows, given the way the markets work, you're either the first half or the second half, given the reporting cycles and so forth. And so those are the 2 windows that we have. And as Tom has indicated, we have the luxury of doing it at the time it makes the most sense. We have to look at all the factors and do it at the time that makes sense. We'd certainly hope to do it in the first half, but we'll have to see if that's achievable or if it's better to do it in the second half, and we'll obviously provide updates as we go.

[Operator:]

And ladies and gentlemen, I will now turn the call back over to Mr. McInerney for closing comments.

[Thomas Joseph McInerney:]

Thank you, Catherine, and thanks to all of you for your time and questions today. As you know, Georgette Nicholas has been promoted to a new role as CFO of our Australia Mortgage Insurance business, and so she'll soon leave for Sydney. I want take a moment and thank Georgette for all of her accomplishments as Head of Investor Relations. I know you share that sentiment, based on all the positive feedback that Marty and I receive about Georgette, David Rosenbaum and the entire IR team. We're also delighted that Amy Corbin, who is the CFO of our U.S. Life Insurance Division, is taking over for Georgette as Head of IR. And many of you know Amy, and I'm excited to have her assume this very important role on behalf of the company. 2013 was a year of significant improvement at Genworth, and we executed well on our turnaround strategy. As we enter 2014, I'm excited about the continued opportunity we have to execute our strategy and add shareholder value. We have a strong management team and talented employees that have endured a lot of changes during the last few years, and we remain focused on our top priorities for 2014, as we outlined today, and continue to protect families at life's moments of truth and help families achieve and maintain the dream of homeownership.

[Operator:]

Ladies and gentlemen, this concludes Genworth Financial Fourth Quarter Earnings Conference Call. Thank you for your participation. At this time the call will end.