Genworth Financial (GNW) Reports 1Q13 Results

Genworth Financial (GNW) reported 1Q13 earnings on April 30, 2013 [Source]. At the fourth quarter 2012 earnings release we described Genworth as “a work in progress” this quarter it is more about “progress in works”. Reported results are good and considering the fundamental progress behind the scenes for the future, the results are excellent. Our thesis remains on track [Source].

The headline news is “Genworth’s Profit Doubled” as Genworth reported net income of $103 million, or $.21/share, compared with $46 million, or $.09/share in the first quarter of 2012. Net operating income that excludes investing results was $.30/share, compared to net operating income of $17 million or $.03/share the first quarter of 2012.

The real headline news from our perspective is the significant and sustainable improvements being made behind the quarter’s numbers. These improvements include the following milestones:

  • The U.S. mortgage insurance business posted its first quarterly profit since 2007 and ahead of expectations in the second half of 2013.
  • On April 1, 2013, the U.S. Mortgage Insurance (USMI) capital plan was completed and a $100 million capital contribution made to USMI lower consolidated U.S. risk to capital from 30.4 at 4Q12 to 24.2 at 1Q13.
  • Importantly, the capital improvements were made without diluting existing shareholder equity by issuing new shares of common stock, an affirmation of managements shareholder friendly focus.
  • In March 2013, agreement was reached to sell the non-core Wealth Management business for $412 million. It is expected to close in the 2nd half of 2013, simplifying the business and freeing cash for debt reduction.
  • Aggressive rate increases on Long Term Care (LTC) unprofitable legacy policies continues to be implemented nationwide and tighter underwriting standards implemented on new policies.
  • Sales of LTC were suspended in California in March, 2013 until policies and rates with acceptable risk adjusted returns were approved by regulators. Now approved sales in California will resume  during 3Q13.
  • Further illustrating management’s commitment to improving LTC, Genworth announced cessation of new sales of AARP branded long term care insurance products on June 1, 2013.
  • Credit agencies are taking notice: in January, Moody’s reaffirm the rating of the holding company and revised the outlook to stable; last week S&P reaffirmed the rating of the holding company, but maintained a negative outlook; on USMI S&P maintained their rating and revised the outlook from negative to stable, reflecting the improved performance and impacts from the capital plan.
  • The new CEO is demonstrating he understands the issues and taking methodical actions to address them in a shareholder friendly manner.

Press Release [Source] Genworth Financial Announces First Quarter 2013 Results:

  •  U.S. Mortgage Insurance Profitable
  • U.S. Mortgage Capital Plan Completed April 1
  • U.S. Life Insurance Division Results Improved From Favorable Mortality
  • Agreement Reached To Sell Wealth Management Business For $412.5 Million

Richmond, VA (April 30, 2013) – Genworth Financial, Inc. (NYSE: GNW) today reported results for the first quarter of 2013. The company reported net income of $103 million, or $0.21 per diluted share, compared with net income of $46 million, or $0.09 per diluted share, in the first quarter of 2012. Net operating income first quarter of 2013 was $151 million, or $0.30 per diluted share, compared with net operating income of $17 million, or $0.03 per diluted share, in the first quarter of 2012. 

“We achieved several milestones in the first quarter of 2013, including progress on our long term care premium rate increase plans, the announcement of the sale of our wealth management business, execution of the U.S.

Mortgage Insurance capital plan on April 1 and reporting a profitable quarter in that business,” said Tom McInerney, President and CEO. “I am pleased with the progress on execution, but we must continue to focus and take action on our plan for rebuilding shareholder value.” GNW 1Q13 Consolidated Income

Net investment losses, net of tax and other adjustments, were $28 million in the quarter compared to net investment gains of $17 million in the prior year. Total investment impairments, net of tax, were $7 million in the current quarter and $10 million in the prior year. 

In March 2013, the company entered into an agreement to sell the wealth management business. Beginning in the first quarter of 2013, this business is being separately presented as discontinued operations and all prior periods herein have been re-presented.  During the quarter, the company recognized $27 million from a goodwill impairment and other loss related to the sale of the wealth management business, partially offset by $7 million of income from discontinued operations. The company expects the transaction to close in the second half of 2013, subject to customary closing conditions, including requisite regulatory approvals, and anticipates recording an additional after-tax loss of up to $10 million at that time. Assets under management as of March 31, 2013 for the wealth management business were $23.1 billion. 

The company has a practice of refunding the post-delinquent premiums in our U.S. mortgage insurance business to the insured party if the delinquent loan goes to claim. The company’s historical accounting practice was to account for these premium refunds as a reduction in premiums upon payment. In the first quarter of 2013, the company determined that it should have been recording a liability for premiums received on the delinquent loans where its practice was to refund post-delinquent premiums. This error was not material to the company’s consolidated financial condition, results of operations or cash flows as presented in its previously filed annual and quarterly financial statements; however, the adjustment to correct the cumulative effect of this error would have been material if recorded in the first quarter of 2013. The company restated the financial information to correct this error for all periods presented herein. The cumulative decrease to retained earnings was $46 million as of January 1, 2012.

Net operating income (loss) results are summarized in the table below:

GNW 1Q13 Division NOI

Net operating income excludes net investment gains (losses), goodwill impairments, gains (losses) on the sale of businesses and other adjustments, net of taxes. A reconciliation of net operating income (loss) of segments and Corporate and Other activities to net income is included at the end of this press release.

An update on how these results compare to what we thought would occur in our investment thesis [Source]:

Our investment thesis is that a turnaround is underway on both a macro and micro level but largely overlooked by the investment community. The nine improvements we listed and results to date are:

1. The U.S. housing recovery is underway and GNW’s domestic mortgage insurance will survive. Following national trends, GNW’s U.S. Mortgage Insurance leading indicator of new mortgage loan delinquency payments continue to decline as the “bad book” from the housing bubble continues to decline as reported by GNW [Source].


Note the percentage of insurance if force written during and after 2009 in the chart above, post the housing crises, is increasing as a percentage of total insurance in force. These new policies were issued with much tighter underwriting standards and will continue to improve U.S. Mortgage Insurance earnings going forward.

In the graph below representing all insurers, a much lower percentage 90 day default for 2009+ vintage compared to earlier vintage policies and stronger pricing indicates a significantly improving mortgage insurance market nationwide.

LPS February Underwriting by Vintage

[Source] page 18 reflects the national trend as of February, 2013 as reported by Lender Processing Services

2. Unlike mono-line domestic mortgage insurers, GNW has other resources to fund the recovery. This is covered in the Genworth (GNW) Announces Resourceful Capital Plan post on 1/16/13 [Source]. It was handled very favorably for us equity owners. Genworth’s mortgage insurance competitors Radian and MGIC raised capital selling debt and issuing about $400 and $700 million in new equity diluting existing shareholders. Genworth utilized other resources to avoid diluting existing shareholders and selling shares below book value. This is a real testament to management’s shareholder friendly approach.

3. Competitive and structural changes in U.S. mortgage insurance will lead to increased industry profitability. Although not an explicit part of our valuation, but a huge potential upside option, the U.S. government is pulling back from the mortgage insurance business. It will take some time for this picture to unfold but management has commented on already firming mortgage insurance prices as the Federal Housing Authority falls under scrutiny for underwriting losses.

4. GNW’s international mortgage insurance business is profitable and improving [Source].

GNW 1Q13 Global MI

5. Long-term health care is profitable and growing concerns are aggressively being addressed. There is still a lot of work to be done in Long-term health care but it has been getting management’s attention. In earnings conference call Tom McInerney, President and CEO opened his comments with: “This morning, I want to focus, first, on steps we are taking to improve business performance, which is where I’ve been spending most of my time…”

“So I’ll begin with where I’m spending most of my time, improving business performance. As we move forward, we are working to offer valuable products and services that help consumers plan for their financial security. We must balance demand for products through strong distribution relationships, with the objective of earning an appropriate return over the required cost of capital for shareholders. A prime example of where we are working to obtain this balance is in our approach to managing a long-term care insurance business. I’ve been meeting with a number of insurance commissioners and state representatives to discuss the rate increase actions and approach.”

The approach:

  1. First stabilize the in-force portfolio through rate actions
  2. Introduce new products attractive to both consumers and shareholders
  3. Significant price increases necessary on older policies to reduce the strain in earnings and capital
  4. Potential needed increases on newer blocks on policies issued since 2004
  5. Closely track experience and, as warranted, file for smaller rate increases sooner and more frequently
  6. Work with state insurance regulators to discuss options to achieve this result
  7. Introduce new long-term care insurance products that are more tightly underwritten
  8. Use more conservative assumptions and benefits, (shorter benefit periods, smaller daily options)
  9. Balance the commercial and risk considerations, but be prepared to take actions
  10. Suspending sales…where we cannot offer products within acceptable risk-adjusted return…temporarily suspend sales in California…end sales to our AARP relationship are examples
  11. Introducing new product offerings and pricing changes throughout the U.S. Life Insurance Division
  12. Changes have caused sales to decline significantly in long-term care transitioning and Life
  13. In Life Insurance, increased prices and introduced a new term
  14. Continue to evaluate changes and adjust as needed

6. The financial crisis acted as a catalyst forcing needed management and strategic changes resulting in a more focused company. This has largely been accomplished through shareholder activism and the board of director responding by hiring Tom McInerney an insurance industry veteran as President and CEO followed by the announced sale of the Wealth Management and planned sale of the Life Style insurance segments.

7. Shareholders have a vocal advocate with Highland Capital Management. Highland Capital Management, Seth Klarman’s Baopost Group and John Paulson are significant shareholders.

8. Low investment returns will correct on future inevitable interest rate increases.  This continues to be a significant headwind for all insurers. The prevailing historically low interest rates are not sustainable, however timing for a recovery is impossible to predict. The largest impact is in the U.S. Life Insurance segment, particularly long-term care and universal life insurance. Hedging of interest rate risk exposure helps mitigate the impact significantly.

9. Share buybacks provide an extremely attractive, although yet unused, opportunity to increase share price significantly. No progress to date. Cash from divestitures of Wealth Management is targeted for debt reduction, Life Style Insurance sale or an IPO of the Australian Mortgage insurance business could provide funds for this high potential return capital allocation. Interestingly, there was even discussion during the conference call of spinning of the U.S. Mortgage Insurance business to raise additional cash, something unheard of just six months ago!

In summary the turnaround is underway on both a macro and micro level. Lingering pessimism and misperceptions create a continued buying opportunity with the share price around $10.00 or about $12.00 below our $22.00 estimate of intrinsic value for about a 55% margin of safety.

Long: GNW








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