Genworth (GNW) Announces Resourceful Capital Plan

This plan is resourceful and a significant catalyst for appreciation in the months to come. The plan utilizes the undervalued assets of the company to address rating agency concerns and preserve the still to be recognized value for existing shareholders.

The News Release in Part [Source]:

Genworth Financial (GNW) announced today a comprehensive capital plan for its main U.S. Mortgage Insurance subsidiary:

  1. Reduces USMI’s risk-to-capital by 12 to 15 points;
  2. Decrease the likelihood USMI will require additional capital;
  3. Ensures the ability to write new mortgage insurance business;
  4. Reduces the risk of a default under Glenworth’s senior notes;
  5. Addresses rating agency concerns, preserves investment grade and increases financial flexibility.

“We are very pleased to announce a comprehensive plan for the U.S. mortgage insurance business which reduces linkages and dependencies with the holding company and increases our financial flexibility while bolstering capital in the business,” said Martin P. Klein, chief financial officer. “U.S. mortgage insurance is a key component of our Global Mortgage Insurance Division, and we believe implementation of this plan will increase shareholder value by continuing our ability to write profitable new business while at the same time reducing uncertainties related to our U.S. mortgage insurance subsidiaries.”

The Plan:

1. Will transfer ownership of the European mortgage insurance (EMI) subsidiaries to the U.S. Mortgage subsidiary (USMI). These subsidiaries will provide $200 million of additional statutory capital to USMI. Regulatory approval was received and the transfer is scheduled to take place during 1Q13.

2. Implements a reorganization creating a new holding company “NewCo” to hold the combined USMI/EMI and the existing holding company which will continue to hold all remaining subsidiaries separate from the USMI/EMI mortgage businesses. See chart below.

Capital Plan Structure

Source: Genworth Financial Investor Materials [Source]:

3. The plan creates a structure already approved by Freddie Mac and Fannie Mae and allows the option, if ever needed, for GNW to continue to write new mortgage insurance in all 50 states under adverse conditions. Conditions include: elevated risk-to-capital ratio, the revocation of regulatory waivers, or market share reductions below thresholds.

4. Implements an internal legal entity reorganization creating a new holding company structure to remove the USMI subsidiaries from the companies covered by the indenture governing Genworth’s senior notes.

5. Genworth will contribute $100 million to USMI/EMI as part of the comprehensive capital plan expected to occur 2Q13.

6. The company anticipates the combined risk-to-capital ratio of the U.S. mortgage insurance subsidiaries will be reduced by 8 to 10 points from current levels of about 30.

7. Cash and highly liquid securities at the holding company totaled approximately $1.0 billion as of December 31, 2012 and will remain at the targeted $950 million.

8. Current shareholders will receive shares in the new holding company NewCo, to be renamed Genworth Financial.

Significance to our Investment Thesis and Shareholders:

1. We maintained GNW’s international mortgage businesses were strength contrary to the market’s perception. This announced plan validates that as GNW leverages international mortgage strength to resolve the U.S. mortgage businesses remaining issues.

2. The announced plan is favorable to shareholders in that the problematic but improving U.S. mortgage insurance business was not sold or spunoff near the bottom of the market to the detriment of existing shareholders. Existing shareholders will be able to enjoy the “upside” after suffering through the downside.

3. Options for further operation improvement in Long-term; potential sale of the Wealth Management segment; International Protection segment; and the potential Australia mortgage insurance IPO remain in place potentially raising funds for share buybacks at still attractive prices.

Future Improvements anticipated beyond our Investment Thesis:

A turnaround investment often has two levels of recovery. The first occurs once value investors realize excessive fear drove the share price beyond the underlying value of the company even with the bad news considered. That is where we believe GNW is now. The second higher level of recovery can occur if the company demonstrates it is a future contender in the industry. To do this it must show improved operating results and at that point the more traditional insurance industry investors begin to consider the investment. Although too early to quantify, GNW’s intrinsic value will likely increase beyond our current estimate with the following unfolding favorable events:

The U.S. housing market continues to improve as mortgage delinquencies and foreclosures decline. Surviving U.S. mortgage insurance participants should face improved pricing and favorable mortgage insurance market conditions for years to come.

The U.S. federal deficit has already reduced congress’ appetite for federally funded mortgage insurance. The FHA exposes taxpayers to a potential liability of $1.25 trillion as of 3Q12. This role as a mortgage insurer will likely decline or prices will have to be increased to reduce federal subsidies. Either event is favorable to private mortgage insurers.

To avoid locking out 40-60% of credit worthy buyers (with less than 20% down payment) from an already depressed housing market the role of the surviving private mortgage insurers may very well increase. The FHA is private mortgage insurers’ largest competitor and a reduced role should improve pricing and underwriting standards.

Disclosure: Long GNW

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