Genworth Financial (GNW) 4Q13 Good Results and Expecting More:

Genworth Financial (GNW) reported 4Q13 earnings on February 4, 2014 [Source] and held their 4Q13 earnings conference call the following morning. The company reported net income of $208 million, or $0.41 per diluted share, compared with net income of $168 million, or $0.34 per diluted share, in the fourth quarter of 2012 for a 24% year over year improvement. The 4Q13 net operating income was $193 million or $0.38/share; this is $0.08/share over the $0.30/share security analysts’ estimate.  This compares favorably with net operating income of $161 million, or $0.33 per diluted share, in the 4Q12.

Prospects for continued improvement are encouraging as GNW’s ongoing operations show improvements across the board and significant progress on strategic initiatives. Genworth continues to demonstrate to mainstream investors that the operational phase of this turnaround is real. “We made significant progress in 2013 accelerating the turnaround of Genworth,” said Tom McInerney, President and CEO. “Our fourth quarter of 2013 results were strong and we are particularly pleased with the progress in improving our long term care insurance business and with the good operational performance in the Global Mortgage Insurance Division.”

The company made significant progress on improving business operations through 2013. Operating performance for the year improved over 2012 with net income up 72%, and operating income was up 53%. These improvements continued in the 4Q13 with operating income of $193 million, up 39% from the prior quarter.

In our investment thesis [Source] Genworth’s turnaround focused on the two poorly performing core business areas of U.S. mortgage insurance and long term care (LTC) insurance. Management also identified the sale of non-core businesses and debt reduction as high priorities.

Consistent with our investment thesis the results for the full year 2013 and 4Q13 benefited from an improving housing market and loss profile in the United States.  The market has experienced years of significant and sustained improvement in mortgage delinquencies and foreclosure inventories.

U.S. Mortgage Market Performance:

US Mtg Delinquencies 2013

US Mtg Foreclosures 2013

Black Knight Financial Services [Source]

The initial impacts from premium rate increases in Long Term Care (LTC) insurance policies are beginning to take hold. The improvements in LTC are resulting from an intense review of long-term care insurance business and the balance sheet that evolved into a three part strategy: (1) significant premium rate increases on the older insurance (written prior to 2002) to bring them to a breakeven point; (2) requesting smaller rate increases more proactively on newer blocks to bring them to original pricing assumptions; and (3) new products using improved underwritten and appropriately priced using more conservative assumptions. These changes will result in the LTC insurance being managed more along the lines of health care insurance where risk is continually monitored and proactively addressed.

GNW Light House

This sustainable improvement is supported by Genworth’s three year perspectives through 2016 and presented by management [Source]:

Return on Equity:

  • Genworth 7-9%
  • U.S. Life Insurance Division 7-9%
  • Global Mortgage Insurance Division 12-13%

Leverage Ratio Of 20% To 22%

Minimum Adjusted Interest Coverage Ratio of 6X

Achieve Competitive Ratings, Including Driving One Notch Ratings Upgrade at the Holding Company & U.S. Life Companies

Not reflected in the above goals are the prospects for a partial initial public offering (IPO) of Genworth’s Australian Mortgage business during 2014. Management’s comments during the earnings conference call reflect this sentiment: “The Australia IPO is an important strategic priority…The Australia MI business has been performing well, with improving loss experience, and is delivering solid returns and dividends. Additionally, the Australia IPO market activity has increased over the last year…we continue to evaluate the dynamics of the mortgage insurance market in Australia and our customers’ appetite for mortgage insurance. We remain optimistic that these dynamics will be resolved in the short term to allow the IPO to move forward in 2014…”

Mortgage Insurance:

The thesis proposed the U.S. housing recovery was underway and GNW’s domestic mortgage insurance business would not only survive but could thrive over time. This is due to competitive and structural changes in the U.S. private mortgage insurance leading to increased industry profitability. GNW’s international mortgage insurance business was profitable and improving.

Updating key metrics with four recent quarters of data we see mortgage delinquencies continue to decline indicating a future reduction in future mortgage insurance claims. The U.S. mortgage loss ratio remains below 100% showing profitable policies are being sold. When insurance expenses and losses exceed premiums the combined (loss) ratio is greater than 100% and the company is paying out more than it is receiving and incurring an operating loss.  If the ratio is less than 100% the company is receiving more than it pays out and is incurring an operating profit.

GNW Delinquencies

The U.S. Mortgage Insurance (U.S. MI) 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. New insurance written (NIW) slowed in the 4Q13 from a seasonally smaller mortgage origination market.

Delinquencies, a leading indicator of mortgage insurance claims continued to fall following industry wide patterns.  The newer policies written after the housing crises from 2009 forward are 44% of the policies in force and in line with GNW’s estimates of 40% to 45%. Full year loss mitigation savings were $563 million, above the full year target of $250 million to $350 million, as modifications remain strong.


Long Term Care:

The thesis further proposed Genworth’s largest product line, long-term care insurance (LTC) where GNW is the industry leader would remain viable as competitors left the market and GNW addressed changing demographics and spiraling costs. The chart below shows GNW’s ability to maintain a profitable LTC business in the face of these challenges.

GNW LTC 2013

The three part LTC strategy is taking hold with good progress on the premium rate increase approvals on older generations of products written from 1974 through 2001 and newer generation policies written from 2001 through 2007. As of yearend GNW received approvals for approximately $195 million to $200 million of the annual premium increases from 41 states.

The company reports that approximately 84% of policyholders are deciding to pay the approved rate increases, approximately 11% deciding to pay their current premium amount and take reduced benefits, and 5% accepting the nonforfeiture option.  The company believes the high acceptance of the full rate increase illustrates the continued value of the product to policyholders.

In September, GNW began filing 6% to 13% rate increases on long-term care products issued beginning in 2003 and written through 2012. Current premiums on these policies are in the range of $800 million.

At the end of November, GNW began filing the new Privileged Choice Flex 3.0 product with an improved risk profile that has only marginal interest rate risk and lapse risk and with significantly less morbidity risk and has projected returns of over 20%. They expect this product to be launched in the first half of 2014.

The new President and CEO, Tom McInerney, is implementing the needed operation and strategic changes to accomplish the second phase of GNW’s turnaround. The changes have been insightful and are just beginning to take hold. It appears we can expect continued business improvement over the next 2-3 years. As more investors realize these improvements are sustainable the share price closer will continue to approach the intrinsic value of the business adding further to our gains overtime.

Considering we can still buy shares of GNW stock at about $15/share and a current (4Q13) book value of $24.03 we are buying the equity at 62.5% of value. If Genworth can achieve its return on equity goal of 7-9% we will realize a return on our cost of equity of about 11-14%. Not a bad return in today low return environment.

Our thesis remains on track.

Disclosure: Long GNW

Reference: Earnings Release; Genworth 4Q13 Earnings Summary Presentation (Feb 5); Financial Supplement; [Source]












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