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Executives

Alicia Charity - Vice President of Investor Relations

Mike Fraizer - Chairman and Chief Executive Officer

Kevin Schneider - President of U.S. Mortgage Operation

Pat Kelleher - Chief Financial Officer

Analysts

Jimmy Bhullar - JPMorgan

Nigel Dally - Morgan Stanley

Steven Schwartz - Raymond James

Bob Glasspiegel - Langen McAlenney

Andrew Kligerman - UBS

Genworth Financial, Inc. (GNW) Q3 2007 Earnings Call October 26, 2007 9:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to Genworth Financial's Third-Quarter Earnings Conference Call. My name is Jodi and I will be your coordinator today. At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference call.

As a reminder, the conference is being recorded for replay purposes. Also, we ask that you refrain from using cell phones, speakerphones or headsets during the Q&A portion of today's call. I would now like to turn the presentation over to Alicia Charity, Vice President Investor Relations. Ms. Charity, you may proceed.

Alicia Charity

Thank you, Jodi, and welcome to Genworth Financial's third-quarter 2007 earnings conference call. As you know, our press release and financial supplement were both released last evening and are posted on our website.

We also posted updated investor materials on our U.S. mortgage insurance business to reflect third-quarter results. This morning you will first hear from Mike Fraizer, our Chairman and CEO, then Kevin Schneider, President of Genworth's U.S. mortgage operation, and finally from Pat Kelleher, our Chief Financial Officer.

Following our prepared comments we will open up the call for a question-and-answer period. Pam Schutz, Executive Vice President of our retirement and protection segment; Tom Mann, Executive Vice President of our international and U.S. Mortgage Insurance segment, and other business leaders will be available to take your questions.

With regard to forward-looking statements and the use of non-GAAP financial information, some of the statements we make during the call today may contain 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 or the risk factor section of our most recent annual report Form 10-K filed with the SEC and in our Form 8-K filed with the SEC on April 16, 2007.

Today's presentation also includes non-GAAP financial measures that we believe may be meaningful to investors. In our financial supplement non-GAAP measures have been reconciled to GAAP where required in accordance with SEC rules.

And finally, when we talk about our international segment results, please note that all percent changes exclude the impact of foreign exchange. And with that let me turn the call over to Mike Fraizer.

Mike Fraizer

Thanks, Alicia. Today we'll focus on three key topics. I'll provide an overview perspective on the business, what's going well and where we see challenges. Then Kevin Schneider will discuss the U.S. mortgage insurance business. I will note that we made $39 million in the quarter in this business line, a testament to our risk management practices. And finally, Pat Kelleher will talk about overall quarterly results and our earnings outlook.

Let me start with parts of the business where I think we're hitting on all cylinders. First, our international business continued to deliver strong earnings growth and represented 35% of net operating earnings in the quarter. Importantly, we have strong sales momentum and a growing global presence.

In our established platforms we are penetrating our customer's value chain through strong product offerings and differentiated service and we are prudently growing our global footprint, taking product expertise in payment protection and mortgage insurance to new international markets.

Now at the same time, we manage risk carefully in these markets. Second, I'm pleased with our fee-based retirement and managed money businesses. As our sales and AUM growth demonstrate, the market need is clear and we're gaining penetration with product excellence, service delivery and more effective wholesaling.

We're also making good progress in our life franchise in particular growing our position in the universal life market. The insurance brokerage channel, where we have a leading position, is transitioning to selling more universal life, relying less on term life and we are leveraging that.

Finally, we are making positives strides in long-term care. We officially launched the AARP relationship this month. We now have access to AARP's 39 million members through the Web, career agents and telesales and we expect to see premium flows emerge early in 2008. We're making progress implementing our old block rate action.

We've filed in 47 states so far and received at least partial approvals in 13 states with all approvals in the 8 to 12% range requested. To date we have seen virtually no impact on new sales from this action and early validation of our responsible measured approach to rates in this market. We also face challenges. Clearly the U.S. housing market is impacting our U.S. mortgage insurance results, this is a function of the cyclical nature of this business and, in particular, markets excesses in recent years.

Captive reinsurance coverage on just over 60% of our book provides a nice backstop to absorb a significant level of losses that may develop. Looking more specifically at the mortgage insurance block in the U.S., I feel good about the risks we avoided such as subprime bulk, second liens and under weighting California.

However, there are areas we could have written less, like in Florida, or been even more underweight, like in alternative products. Looking ahead I do think the nature of some product types, risk cut off levels, geographic availability of certain products and underwriting practices will shift for the better from this cycle with many of these well underway.

I also think the rapidly expanding market for mortgage insurance in the U.S. is a real plus. The new business layers being generated from late 2007 forward should demonstrate strong profitability and we are comfortable with both our growth capacity and capital levels.

Now let me turn the call over to Kevin Schneider. Kevin?

Kevin Schneider

Thanks, Mike. This morning I will share my perspective in four areas, U.S. housing market dynamics, how Genworth is positioned, the tremendous revenue opportunity and, finally, our outlook for U.S. mortgage earnings.

As you've all seen, heard and read about, the dynamics of the housing market worsened over the past few months and the turn was rather abrupt. Excessive use of nonprime products and product design approaches such as teaser rates on short-term adjustable-rate mortgages enabled borrowers to get into homes that they ultimately could not afford.

So as teaser rate resets drove defaults and contributed to a liquidity crisis, not only did we see impacts in the subprime markets, we experienced adverse trends in alternative products and saw a contagion effect more broadly as increased housing inventory caused regional declines in home prices.

This eroded or eliminated home equity cushions, which have in the past absorbed the events of defaults. This impact has been more prominent in parts of the country with high nonprime product concentrations. Genworth fortunately limited concentrations in states we believed would be most susceptible to home price declines.

We also limited our participation in nonprime products, we did not participate in subprime bulk, we avoided higher risk second liens and under weighted the industry in products like Alt-A and loans below a 620 FICO score.

Nonetheless our portfolio is feeling pressure from the reduction in liquidity and the declines in home prices and, frankly, the impact is even more extreme than we anticipated. The MSAs we previously identified as high-risk due to extremes price appreciation, including those in Florida, California, Arizona and Nevada, are now playing out even more severely than when we sought to limit our exposures, like in California where we only have 4% of risk in force.

Based on these trends our outlook now anticipates up to a 5% decline nationally in home prices in 2007 with a similar scenario in 2008. We expect significant variation among MSAs; in areas such as Naples, Florida or Santa Barbara and Stockton, California we expect home price declines in the 10% to 15% range, while other areas like New York City and Dallas should see modest increases in home prices.

Turning to losses in the quarter, paid claims remained within our forecast and we had a $75 million net increase to reserves primarily from increased delinquencies in Florida, California, Arizona, Nevada and, to a lesser extent, the Great Lakes, along with the alternative products such as Alt-A and A Minus.

Genworth remains aggressive in working with borrowers and servicers to restructure, modify or workout delinquent loans and we have over 80 people dedicated to doing just that. Turning to performance by book year, our 2004 and prior books continue to perform better than pricing, driven by seasoning and embedded home price appreciation.

We believe our 2005 and '06 books will perform above targeted loss expectations. Although early the first half of '07 should perform more like '06 and performance should improve in the latter half of the '07 book. Approximately 60% to 65% of the 2005 through '07 books have captive reinsurance and we expect them to attach. These are lender-by-lender agreements and will attach on a lender-by-lender basis.

At this point most of these books are about one-third of the way towards their attachment point. We expect the 2006 and '07 books to attach in 2009 and that the 2005 book will more likely attach in the 2010 to 2011 periods.

In an extreme scenario this could absorb up to $1 billion of losses with nearly $840 million currently held in captive trusts. Once these attach the captive pays the losses, in other words, captives provide a floor on the lifetime returns of these books in the 10 to 12% range.

As we look to 2008 we will continue to drive revised product and underwriting standards in response to market conditions and we are working closely with the GSEs and our lenders to ensure the market in 2008 and beyond is characterized by products that better address both consumer and risk management needs.

The great news is that the top-line growth dynamics for mortgage insurance are strong and we see this continuing in the years ahead. In the first nine months of '07, while mortgage originations are down an estimated 12%, we believe the mortgage insurance market has grown almost 60% or $75 billion. Mortgage insurance penetration is estimated to have nearly doubled to 10% in the first nine months and was nearly 14% in the third quarter.

Lenders are tightening underwriting standards and shifting to fixed products, reporting strong high-quality growth in mortgage insurance. Simultaneous seconds have dropped to about 22% of the market and GSE penetration in the mortgage-backed security market is also up sharply, estimated at over 70% this quarter. The strong flow mortgage insurance market growth and our selective participation in prime bulk transactions has resulted in revenue growth of 22% on a year-to-date basis.

The bulk business is performing well with losses in line with pricing expectations. It is important to note that we are comfortable with our current prime bulk growth due to our past decisions not to participate in subprime bulk. At that time we saw inadequate pricing and underwriting and doubted the availability of successive books, issues that are indeed impacting the mortgage industry today.

Looking to the fourth quarter, we expect revenue growth and expense productivity to partially offset a continued increase in losses. While we are adding more to reserves than originally anticipated, we expect to end the year with earnings in the $170 to $200 million range. We expect 2007 paid claims in the range of $160 to $185 million, consistent with our prior outlook, and for the full year a loss ratio in the range of 60% to 70%.

Turning to capital, we remain well capitalized to support targeted business growth during this period of higher losses. This quarter we worked closely with our regulators and the rating agencies to extract $300 million of excess contingency reserves and executed a $350 million dividend to the holding company.

We remain committed to maintaining our AA ratings and we believe we have the capital to both handle the current loss cycle and fund growth. Looking ahead to 2008 we expect earnings at or modestly below the 2007 level and we will provide additional detail on earnings and capital planning on our strategic update call in December. With that I'll turn it over to Pat.

Pat Kelleher

Thanks, Kevin. This morning I'll cover three topics. First, the strong growth we saw in the quarter, second, I'll discuss the impact of recent volatility in financial markets on Genworth, third, I'll cover financial targets including expenses, taxes and capital management, and then I'll wrap up with our outlook.

Let's start with the international platforms where operating earnings were up 20% on an FX adjusted basis. Canada delivered stellar performance with flow NIW up 27% both from growth in the high loan to value market and from market penetration. The loss ratio in Canada at 18% remained strong and consistent with our expectation that the loss ratio will season over time following a period of very low loss experience.

Australia earnings were up 23% as higher earned premium more than offset the higher loss ratio. New insurance written growth in Australia was driven by $7 billion of low loan to value bulk production. Finally, payment protection continues to deliver solid growth in continental Europe including nice progress in newer markets such as Poland.

Now let me turn to the strong growth in our fee-based retirement and wealth management businesses. Our managed money business outperformed the market with AUM growth of 50% due to expansion of sales forces, new products and service excellence. Sales of income distribution products rose more than 60% from increased penetration with product excellence, service delivery and expanded wholesaling.

We saw similar growth in universal life insurance as our brokerage channel transitions to selling more of this product, offsetting the drop in term life sales where competition is steep. Universal life no lapse guarantee product sales were strong as were sales of large case policies reflecting our increase in per policy retention last year.

Long-term care sales also showed nice growth largely from our life and long-term care combo product and from strong growth in career agency sales. Independent channel sales were slightly below last year but up about 11% adjusting for the sales pickup ahead of last year's new business price increase in California.

Now I'd like to share three perspectives associated with the current financial markets; these relate to our high-quality investment portfolio, our capital markets plans and our international businesses. In our investment portfolio we see an opportunity with wider credit spreads to improve the portfolio yields.

Credit performance remains good with just $16 million after-tax of total impairments of which $11 million related to losses on securities backed by subprime and Alt-A residential mortgage collateral. Looking at gross unrealized losses, unprecedented conditions in the structured market impacted securities backed by subprime and Alt-A collateral where market values declined from 99% of amortized cost in June to 87% in September for subprime and from 98% to 96% of amortized cost for Alt-A.

We currently expect to hold these securities to maturity and are comfortable with the external valuation data used to set market values. Next, recent capital markets conditions also have constrained the asset-backed market. We view these constraints as short-term and that market conditions will normalize and plans for new securitizations are moving forward.

Finally, recent financial market conditions have favorably impacted our international results. U.S. dollar declines against the Canadian dollar, the euro and the Australian dollar resulted in foreign exchange adding $193 million to book value in the quarter and $416 million year-to-date. And finally, foreign exchange contributed $12 million to earnings for the quarter.

Turning to expenses and taxes, our adjusted expense ratio is down a full point from last year and we expect to meet our two-year savings and efficiency goal of $220 million with approximately $75 million falling to the bottom line. On the tax front we've improved the relatively inefficient tax structure we had at the time of our IPO, this progress can vary in quarterly reporting as it added $0.04 to earnings per diluted share in our retirement and protection business this quarter.

On a full-year basis we're on track to deliver our objective of an effective tax rate close to 29%. On the capital front we completed our 1.1 billion-share repurchase authorization buying 102 million in the quarter. We raised our quarterly dividend to $0.10 per share and we're holding to a payout range of at least 11% to 12%.

As Kevin mentioned, we had a $350 million dividend from the U.S. Mortgage Insurance business and we now expect to end the year with about $900 million of capital capacity, nearly double our previous estimate. This positions is well to fund our strategic growth priorities including international expansion and continuing to build our fee-based retirement and wealth management position.

Finally, let me offer some perspective on our earnings outlook. Through nine months we delivered good 15% operating earnings per share growth despite higher losses in the U.S. Mortgage Insurance business. However, given the ongoing difficulties in the U.S. housing market we expect our 2007 net operating earnings per share in the $3.00 to $3.10 range.

We expect U.S. Mortgage Insurance earnings in 2008 to be flat or down modestly from 2007 levels as the loss cycle continues offset by continued strong revenue growth. Currently we see pressure of achieving our 12% operating ROE target in 2008 and we will see how the fourth-quarter delinquencies play out and provide an update on our December 11th call. Over the longer-term, we expect to achieve the 13 to 14% ROE goal we have established for the 2010 to 2011 timeframe.

With that I'll open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jimmy Bhullar with JPMorgan.

Jimmy Bhullar - JPMorgan

I have a couple of questions. The first one is on capital. I think your buyback authorization has been exhausted, but if you can comment on whether you intend to go to the Board and ask for another authorization considering how much your stock price has declined and just take advantage of that?

And the second one is on your life business. You've been mentioning the past couple of quarters that you've had adverse mortality, your benefits ratio in that business has gone up consistently the last several quarters.

I think the most recent quarter it was 86%, the last few years it's been 79 to 83. So, if you can just talk about whether you feel comfortable that the underwriting in that business is not an issue.

And the strong sales growth over the last few years was not partly because of aggressive pricing and whether you feel comfortable with the margins in that business long-term? And that's all I have.

Mike Fraizer

Thanks, Jimmy, two great questions. Let me start with the first and I'll give it to Bill, goings on the life question second. Certainly when we look at our capital position, as Pat said, we feel very good about it.

We're in our annual planning process right now, not only on an '08, but a multi-year basis, and of course capital deployment is part of that. We will make sure that we can fund what are very strong core growth opportunities such as in our retirement lines, international lines.

Kevin talked about U.S. mortgage insurance, as well as make sure we have some capital available for some concepts in the acquisition pipeline as well. I'll remind you that of course we have been a company that looks to both repurchases and dividends on top of that.

We bought back over $2.6 billion of stock since our IPO and we've also raised our dividends over 50%. So of course we will look at repurchases as well as our dividend plans as we go through that planning process and we do have Board meetings later this year.

So we'll be very thoughtful and certainly consider that, and that we've had a track record of balancing all four levers in capital deployment. Bill, do you want to…

Jimmy Bhullar - JPMorgan

And just a follow-up on that, the stock price declining, does that affect the priority list that you have in terms of what to look at with excess capital?

Mike Fraizer

Think about it this way, Jimmy, you can't repurchase your way to success in building a business and building shareowner value on a multiyear basis. So certainly it's a very important and a good lever to use.

And certainly we look at the relative value and the return you get and we run the models the same way you do as far as looking at the return you get at different price levels. So we'll be very thoughtful in looking at that and give it an appropriate weight.

I have had investors say why don’t literally -- why don't you slow down growth and just buy back stock? I don't think that's a good business equation. I think you want to fund good growth.

We have good acquisition opportunities. Yes, you want to look at repurchases and dividends. And also you want to keep a certain buffer of capital that you need for both ratings and regulatory shifts that happen either on a domestic or a global basis from time to time, which is a characteristic of the industry we're in.

So that's how I think about it. Bill, do you want to pick up on the life side?

Bill Goings

Sure. You had three questions about mortality, growth and the margins in the business. On number one, I'd like to emphasize that this quarter that the overall life business mortality is favorable to pricing, and year-to-date it remains favorable to pricing.

And so we feel very comfortable about where we are from a mortality point of view. You have to recall that you're looking at an extremely favorable year in 2006. But we monitor these trends closely and update our pricing and underwriting criteria as necessary.

Secondly, you referred to the growth. I feel very comfortable with the overall sales this quarter as it relates to the life business. Again, the term market is very competitive where you see us actually declining in sales.

But our strong progress in universal life is really due to the fact that our primary distribution is headed that way. We have very competitive no lapse guaranteed products. We've enhanced our capability around wholesaling, increased our retention, broadened our product suite, et cetera, to continue to grow that business.

And so we feel very comfortable with the overall margins and very comfortable with the overall growth profile for this business.

Jimmy Bhullar - JPMorgan

Thank you.

Operator

Your next question comes from the line of Nigel Dally with Morgan Stanley.

Nigel Dally - Morgan Stanley

Great. Thank you, good morning. First, you mentioned you expect a similar level of mortgage insurance earnings in 2008 versus 2007. Given the rates in deteriorations, especially with sharply higher delinquencies, that seems somewhat aggressive.

So I'm hoping you can run through some of the factors that drive your confidence. Second, you extracted capital from domestic MI this quarter despite the deterioration. Perhaps you can spend a little additional time on that decision?

And third, the loss ratio in Australia looks high, if you can discuss what's driving that? Thanks.

Mike Fraizer

Nigel, let me give it over to first Kevin Schneider, who will hit on both the first two questions and then I'm going to give it to Tom to talk about Australia. So Kevin, do want to kick off on that?

Kevin Schneider

Yes. Nig let me -- In terms of next year's outcomes and the range of outcomes to allow us to achieve that sort of flat to downish level, let me give you a couple of scenarios to think about.

And one is if revenue growth grows 30% to roughly $1 billion next year we're reflecting the high levels of persistency and the continued strong mortgage insurance market that we have right now.

And losses increase to $600 million our loss ratios would be at about the 75% range and we would generate revenues in the $170 million to $200 million range.

Alternatively, based upon ongoing loss development with the same level of revenue growth, if our losses grew to a $700 million level the loss ratios would push about 90% and we'd still generate in the $100 million range.

So there is a number of different ways of modeling this and we will commit to the group that will get back with some updates and conditional clarity on how to think about that in our December meetings.

Mike Fraizer

Let me just, one clarification. Kevin, you said $175 million to $200 million of revenues, you meant of income, excuse me of income. Do you want to hit on the,

Kevin Schneider

Yes.

Mike Fraizer

Capital extraction plan?

Kevin Schneider

Yes. On the capital side our team reviewed trends within the industry and our portfolio along with our capital position with both our regulators as well as the rating agencies to support the removal of that dividend request while maintaining our AA rating.

And part of that discussion was a reminder that -- to remember that we hadn't done the subprime bulk business and we hadn't done any material second lien insurance that others in the industries might have done which were materially impacting their losses.

So while our losses increased in the third quarter we remain well capitalized to support AA rated stress loss scenarios. And we're going to continue to work with our regulators as they perhaps refine their models in this current environment.

Mike Fraizer

Tom, do you want to pick up on Australia?

Tom Mann

Sure, Nigel, thanks for the question. The first thing I would like to step back and point out is that we had a great quarter in Australia. Our foreign exchange FX adjusted growth was over 20%, so we saw excellent revenue growth to offset increased losses that you alluded to.

The way I think about the losses though is to really look at the loss ratio over the past four quarters and also the absolute losses that we've had. We're very pleased with the fact, Nigel, that the loss ratio in the third quarter was at 49%, which is just up a tick over the 47% that we had in the prior quarter.

And I think 2 points over what we had in the first quarter and our absolute level of losses quarter-to-quarter, second quarter, third quarter were relatively flat as well. The story in Australia is pretty similar to what we've had in the past.

As you may recall, we have about 22% of our book is 2003 or prior, strong embedded home price appreciation in that and performing well below pricing. We're still working through our '04 and '05 books about 30% of our risk in force concentration is there. You may recall that we have now isolated our limited distribution partner issue we're working through that.

Those books are also being impacted by a weakness in the western suburbs of New South Wales. So we do expect that they will perform at above our pricing levels.

And again 2006, 2007, a little bit early to call, but we feel very comfortable with those books as well. So long story short, we're very pleased with the results in Australia.

Nigel Dally - Morgan Stanley

Great, thank you.

Operator

Your next question comes from the line of Steven Schwartz with Raymond James and Associates.

Steven Schwartz - Raymond James

Nigel just asked a bunch of them, but Kevin, could you just walk us through once again because it's been awhile since we revisited it -- kind of how the vintages age, when they hit their peak in terms of losses and when they begin to come down?

Kevin Schneider

Yeah. Let me just give you a way to think about that, Steven. If you look at for example our 2003 books -- excuse me, if you think about delinquencies, generally your delinquencies hit their peak about two years following, two to three years following, three years following the origination of that book depending on how the book feathers in. And then your ultimate claims speak about a year later.

So, if you think about our books right now, our 2003 book has already peaked in terms of its delinquencies and its peak claim rate. The '04 book essentially peaking -- will be peaked through this year in terms of its delinquency levels with claims feathering in through next year.

And in the '05 and '06 books, which are probably the more important thing to be looking at right now, we would expect those books to peak in terms of delinquency in '08 and '09 respectively followed by the peak loss levels a year later.

Steven Schwartz - Raymond James

Okay. And then, just another question, kind of again a tutorial here on captive reinsurance. Generally speaking, where does that begin to attach? I know it's different for every different thing, but if you can give us a sense?

Kevin Schneider

Captive reinsurance agreements and let me give you an example of a common structure in the industry, which is called a 40 excess of loss agreement. In those agreements, when losses achieve 4% of the original risk in force of that book. Then at that point, the captive attaches its attachment point.

So, that is highly dependent on the nature of the business within the captive. It's very dependent on individual lenders and their origination practices. And it's very dependent on the persistency of that book and how that book sticks on in policies in force for us.

Steven Schwartz - Raymond James

Okay, great. Thank you very much, Kevin.

Operator

Our next question comes from the line of Bob Glasspiegel, Langen McAlenney.

Bob Glasspiegel - Langen McAlenney

Good morning. Thank you very much for the increased mortgage disclosure. As I look at page 5, it looks like your '07 vintages have the highest loan to value and the worst FICO scores.

This is a period of time where you sort of have the best and the worst of times. I guess, you have the beginning of the year where the business was the worst priced and then you put your foot on the gas pedal about midyear. But it seems like the conditions have been deteriorating on a weekly basis.

How can we be confident that the more recent vintage of '07 is in fact properly underwritten in light of the statistics on this page?

Kevin Schneider

Excuse me -- I believe you're referring to the statistics on the portfolio by vintage page.

Bob Glasspiegel - Langen McAlenney

Right.

Kevin Schneider

I just want to make sure I'm in sync with you.

Bob Glasspiegel - Langen McAlenney

Page 5.

Kevin Schneider

Yeah, let me tell you how we think about 2007. In general, the beginning of 2007 is more likely to look like the 2006 book. Much of that was actually probably begun to be originating in the latter part of '06 and then spillover into 2007.

I wouldn't characterize that we'd put our foot on the accelerator in the second half of '07. What I would characterize is that there was a continued shift to improved underwriting, sounder underwriting standards, sounder product, improvements in pricing, improvements in guidelines across the board.

So the latter half of '07 should demonstrate higher performing books. So, as kind of -- as the year has gone on the improvement in the underwriting in book and the business that we have written just continues.

The pricing has gotten better, but the acceleration and the amount of volume in the market is really driven by a shift back to more conservative lending practices and a revaluing of the value of mortgage insurance as compared to some alternative products.

Bob Glasspiegel - Langen McAlenney

So will we see the effect of LTV go down a lot in the fourth quarter and will we see the FICO scores go up?

Kevin Schneider

FICO scores over time haven't varied tremendously across all of our businesses. I think as we -- in terms of on a written basis, on a new business written basis you will continue to see pricing improvements, you'll continue to see reductions in some of the higher loan to value portions of the book.

And FICO scores will be impacted somewhat because we're going to have – we have pulled back on some guidelines and are restricting some of the lower-level FICO business that we did in the past.

Mike Fraizer

Tom, do you want to provide any additional perspectives?

Tom Mann

I sure can. And Bob, I think it's a great question. I think as you move ahead in the 2007 book you're going to see two offsetting drivers. I think, there's going to continue to be a discernible move to reduce the original loan to values that we will be underwriting.

But at the same time, if we have continued housing declines next year, that will serve to offset that benefit. But we're going to try to manage that effective loan to value down as effectively as we can. And on the FICO scores as well, earlier in the year when you saw the massive liquidity drain in the sub-prime market of some of that business began to flow back through the GSE systems.

And so, we did have a tick up in our less than 620 business. But again, as Kevin mentioned in his written comments, we are working closely with both Fannie Mae and Freddie Mac to ensure that we are developing and insuring and therefore in their guaranteed business and portfolio responsible consumer products.

So, I think you're going to see a discernible direction in the latter part of '07, and in particular '08, to continue to push down those FICO -- excuse me, push up those FICO scores.

Bob Glasspiegel - Langen McAlenney

Okay, if I could change gears, long-term care, you're releasing reserves and raising prices. In most lines of insurance, I have found that when the business has been under priced more likely it's been under reserved and overprice leads to over reserving.

Maybe you could explain just how that's happening this quarter and then I guess throughout the year?

Mike Fraizer

Bob, let me give you a quick perspective. You're sort of mixing apples and oranges there. That the color on it is we're making the moves, we are on the old block, those are going well, as I outlined.

On the one reserve you basically have the correction of a coding error, but that's not for old stuff, that's just how a product was set up in 2006. So, it's new stuff and we had to correct the coding error. So we were over reserving on new much higher priced product, which is our very profitable product. And unfortunate that it happened, it happened, we cleaned it up.

Bob Glasspiegel - Langen McAlenney

I thought there was another reserve release this year as well, but maybe that was the same issue. But you're still comfortable with the old block of reserves I take it?

Mike Fraizer

Yes, we're comfortable with the reserves and, again, we're putting in the additional margin. I think from that margin perspective you'll start seeing premium coming gradually through '08 and you get by the end of '08 and then we ought to have the full benefit of what will average to around a 10% rate move in that old block.

Bob Glasspiegel - Langen McAlenney

Thank you very much.

Mike Fraizer

Thank you.

Operator

Our next question comes from the line of Andrew Kligerman with UBS.

Andrew Kligerman - UBS

Let me ask a few questions around the U.S. mortgage insurance. Maybe we could start with your views on HPA and default rates as you look to '08 and you made these assumptions of a flat to down earnings environment for USMI.

Mike Fraizer

Kevin, do you want to pick that up?

Kevin Schneider

Andrew, we like many others -- there are a number of different ways of thinking of looking at HPA in the marketplace. The current forecast that we ground ourselves in through economy.com assumes that '08's national home price appreciation is going to go down about 6%.

And what that is average median home price for the total year of '08 over the total year of '07. I think a better way to think about it and the way we think about it when we look at our books is really on a sequential basis and if you sort of go from peak to trough at the high watermark of home price appreciation.

At the end of '05 home prices came down about 3% in '06, they're expected to come down about 5% further in '07, and the current view again out of the economy.com forecasting is about 2% further decline in '08.

I think there might be some pressure on that in '08 and that number could be further eroded. But at this point in time, we think about it in terms of about a 10% reduction sequentially in those numbers.

Those will pressure default rates and in terms of our the modeling that we've got in here, I'm not going to go into our exact default rate modeling assumptions going forward, but you can expect as the 2005, 2006 and 2007 books continued use season through the next 18 months that you're going to have those rates will continue to rise.

But again, some default rate is a function of both defaults as well as policies in force, and we expect we didn’t have strong policy in force growth as well, so that will continue to moderate that, but you're going to continue to see default rates rise as we season through this period.

Andrew Kligerman - UBS

Do you think it could exceed say 4.5% or do you think that's sort of where it stops, the default rate?

Kevin Schneider

No, I think when we come back and follow-up with you in December, I think we're going to give you some additional ways to think about that and model it. Specifically, here I been able, how much growth you'd have to do for that, how much you could actually accelerate that default rate in '08 and into '09.

And then I think one of the important thing to think about is based upon the development of those default rates and the reserving and paid claims associated with it, it really starts to propose some interesting questions about when we start to get the benefit of that captive reinsurance.

Mike Frazier

And, Andrew, this is Mike. Let me just give you another perspective, as you recall in the August, September time frame we put out some additional disclosure, which I think we received a lot of compliments on from the investor community, to help people think about and box both the risk, but also understand the opportunity on the revenue side.

And as we talked investors through that we reminded them that you have to look at more than a variable like home price appreciation this case drops. People get fixated on single percentages and you see some wide-ranging differences by region, as even Kevin touched upon, in the markets.

You also have to consider severity, you have to consider cures and all the very active type of mitigation work that again we have a dedicated team and I think we're probably perhaps the quickest moving on those fronts to mitigate situations.

So, what we're going to do is similar to what we did in August and probably early next week is put out some other ways the investor community can think about the market, how it evolves so you can see both, again, ways to box the risk and see the opportunity as well.

And we'll share that about the types of materials we put on our website as we did in August and I think we'll get a similar favorable feedback.

Andrew Kligerman - UBS

Yes, that would definitely be helpful. And just to kind of wrap up this line of questioning, I think Kevin was talking a bit about the '05, '06 vintages kind of peaking in '09, did I understand that correctly or does it get a little higher in 2010?

In other words, when do you think these rough vintages are going to be done with and we could start to see a decline in delinquencies, foreclosures and numbers starting to look materially better? Will we see that in 2010?

Mike Frazier

I'll give you two perspectives. One is the general rule of thumb that Kevin laid out that sort of you peak three years out on your delqs (ph), and you peak four years out on your claims, is a rule of thumb that we still see consistent with the vintages of books that we have right now.

As we’ve lay out scenarios and ways that people think about it, we do think that you're going to see, because of the revenue generation opportunity, some opportunity in '09, in particular when you match the revenue with the loss development, and we will lay that out for you.

Andrew Kligerman - UBS

Okay. And then just shifting over to Australia; how is the environment out there, I mean how is HPA holding in Australia?

Tom Mann

I’ll take that for Andrew, it is fine. Its again, to take you back, Australia was in a very rapid home price appreciation environment up until 2003.

We saw some interest rate increases in '04 that actually brought the HPA trends down to basically flat in '04 and in '05. In '06 saw a recovery in home price appreciation to the 5% to 10% range.

We're going to see that again this year, which is very healthy in Standard & Poor's. I will point out, as I've said in the past, that New South Wales has not participated as much in that recovery in home price appreciation.

So we remain very thoughtful about our business, our concentrations there. But Australia is a country, if you will, economically is doing very, very well.

And while they have had some interest rate increases, I think about four since mid of last year, again to we've given some inflationary concerns and again some acceleration in housing finance concerns, they continue to manage it very, very well and we remain very comfortable with that environment.

Andrew Kligerman - UBS

And just quickly, New South Wales, what percent of the portfolio is that?

Tom Mann

Well, It is about 30% to 35% of the total portfolio, but what we focus on more specifically is what we finally call the Western suburbs, and they are about 10% to 12% of our book.

That is where most of the home price appreciation, I think my numbers are directionally correct that is where you have had a little bit less, you have had some home price deterioration, I should say, and less appreciation.

Andrew Kligerman - UBS

Super. Thanks for answering the questions on this tough part of the business. Everything else looked great.

Tom Mann

Thanks. I consider Australia a good part of the business too. That is not tough to answer.

Operator

Your next question comes from the line of Ed Spehar with Merrill Lynch.

Ed Spehar

Good morning, everyone. A couple of questions. I think when you talk about the loss curve and the peaking of claims, and you take into account.

Obviously, the favorable top-line outlook in the MI business, Mike, putting those two together, the comments you just made suggest that we shouldn't assume that we have got flat to down earnings in USMI beyond '08, that the revenue -- there is a point here where the revenue starts to offset this seasoning, is that without, kind of forcing you to give us a number.

I just want to know if conceptually that is how we should think about it.

Mike Fraizer

And as you state, we are not making estimates at this point. We also want to see some more data come through; I think that is prudent. And, of course, with the December 11th date scheduled, we are going to have even more visibility as we look forward.

And if you have seen over the past months, we have given a lot of visibility to this area. But what I'm pointing out is this, is we have been examined in a very broad industry context.

And, of course, that’s created some reaction. Perhaps it has created some overreaction, when you really look at the differences and the characteristics of books of business, risk management practices, disciplines and so on.

In some scenarios, I am talking at an industry level, not a Genworth level, you see people, you see loss ratios going up fairly dramatically, you see perspectives given about losses.

But what is missed is people are missing that the revenues were dropping dramatically too, in part because some of those revenues might have been linked to the sub-prime bulk market, and those aren't there anymore.

And that is causing the multiyear dynamics and what effectively are the distortions of loss ratios that's there. What I am suggesting in the case of Genworth is we have a more predictable path of revenue growth.

It is in the channels that we want to be, as far as more flow based opportunistically playing in the prime bulk space. We see that continuing as we look out on a multiyear basis.

And, in fact, some of that is going to ramp up as these layers have come on. And as you get into '09, you have more opportunity for those revenue dynamics to stand out, in relation to the progression and normal seasoning and increasing of losses.

Again, we want to give you some more visibility, but that is where I see more of an opportunity in the '09. The other thing about '09 that, again, Kevin pointed to was the captives.

And I think, again, the captives are an area that people don't understand that well. You’ve seen our tutorial efforts on it. We're going to give some more and some additional disclosures.

Think of captives with sort of a two-step benefit. Once you hit through the claim frequency, you are going to get an immediate benefit in your reserving, because you are effectively at that point starting to accrue a reinsurance benefit.

Now, it may be another year or so, before you get into the paid claims scenario where you're getting the cash benefit.

Those '06 and '07 books, we think will really start showing that accrual benefit and, therefore, that will show up through your reserving in '09, and I don't think people are thinking about that. And then '05, because of more embedded home price appreciation is why that shows in the '10, ‘11.

So that is the other dynamic along with the revenue that leads me to say that I think '09 will be a different profile and one that has some opportunity, though. Let's get a couple of months through here and we will talk about it on the 11th.

Ed Spehar - Merrill Lynch

Okay. And just a follow-up and I guess opportunity doesn't sound like down, I guess, I would say. In terms of Australia and Canada, given the reliance on natural resources based types of economies. How do you think about the impact that changes in commodity prices would have on home price appreciation outlook? How do we price for and make sure we don't have a scenario in those countries like we are seeing in the U.S. today?

Mike Fraizer

Let me hand that over to Tom.

Tom Mann

I'm going to break that up into, I'm going to answer your second part of that question first and then answer your question on the commodity, if you will, dependency to the countries. I think, when we think of all of the global markets today and we need to remember that particularly from a mortgage perspective, they are very, very dissimilar from what that’s happened in the United States.

You have very -- when you look globally with the possible exception of the United Kingdom, you have fundamentally nominal amounts of sub-prime and non-prime mortgage originations. Thus, remember in the United States in '05 and '06, we had about 40% of our originations were in those type products.

Secondly, globally, your mortgage landscape is characterized by fundamentally large banks, deposit-taking institutions. They do access the capital markets, but they have much less comparatively use of the mortgage-backed security markets.

Therefore, if you think about it from a liquidity perspective, which again was the second part of your question, there is simply no real comparable liquidity issues in the global mortgage markets.

Now, the global markets are indeed being impacted to a degree, continue to be impacted by the broad liquidity issue as it relates to the broader economy. But I don't really see it as it relates to mortgages, which leads me to the second point.

When you think about home price appreciation drivers and then all of our markets, I would categorize them outside the United States as simply more traditional. And by that, we have had strong home price appreciation because of our low historical interest rates, strong economies, in many parts driven by the commodity dependency on both Canada and Australia and also by excellent housing demand.

So, when I think about these economies going forward, we will manage them very similar to how we have managed all of our environments. And by that, I mean that we monitored our concentrations of the home price appreciation trends in those areas that have benefited from those facts that you've mentioned that would be Western Canada and also Western Australia.

We manage our loan-to-value concentrations in those environments and then we watch them for how these respective governments are going to manage the downturn or the flattening out that will occur in home price appreciation, by the way, which will inevitably occur.

So while there is a degree of dependency on both those economies on the commodities markets, we are hopeful that it will be monitor down very carefully. But I don't see anything that will happen there that is even roughly similar to the very unique situation that we have in the United States markets.

Ed Spehar - Merrill Lynch

Thank you. That is very helpful.

Operator

Your next question comes from the line of Josh Schmidt with Crest.

Josh Schmit - Crest

Hi, thanks for taking the call. A quick question on the long-term ROE from the cap, because I think you mentioned that 10 to 12 is just sort of a floor. Can you kind of walk through the math? Others have said the same thing, but it appears that if it went bad really, really fast you'd earn enough premium over time to offset that. So if you could walk through that a little bit and then I had a question on the impairment of the investments.

Mike Fraizer

Kevin, do you want to take that?

Kevin Schneider

Without getting into math specifics, Josh, I think the way to think about it is you have continued premium over the life of that book. That which goes bad, obviously, you lose that premium.

But you could have reduced performance of that book on an ROE basis up until the point at which you do hit that attachment. Once you hit that attachment, it's all premium without any losses.

Josh Schmit - Crest

But you're only getting 2.5% premium on the risk in force. So if it went bad, we can take it off-line. The second question on the impairments of the?

Mike Fraizer

Josh, just remember, we don't expect to come out the other side of the captive either.

Josh Schmit - Crest

No, that part I understand.

Mike Fraizer

Just to make sure you understand. Go ahead.

Josh Schmit - Crest

Others have taken significant impairments on their investments and CDOs. I think, HARTFORD took some on their order; Merrill obviously, took massive hits. What is your process for determining whether those assets are impaired or not?

Are you marking it to market? If so what is the market? Is it the ABX, if you could walk a little bit through that?

Pat Kelleher

This is Pat. I'll take it. With respect to our structured investments, we have a couple of processes. The first one is every month we take a look at the experience that's reported on the securities; we take a look at how the developing trends affect our ability to recover interest and principal, as expected over the lifetime of the investment.

And to the extent that we trip any I’ll say switches, in terms of, we've got to look at this one closer, we do a full analysis and determine whether there's an impairment or whether there's value in trading or selling that security. So that's a pretty thorough process and it happens every month as part of what we do. We've also -- yes?

Josh Schmit - Crest

I'm sorry. Just is there -- when you're making that determination are looking at a specific market that can tell you whether that's impaired or not or you have your internal models, what's?

Pat Kelleher

That gets to the second part of how we look at this, and that is every month. What we do is we go out to an external service and we get market prices on all of our securities.

And over the course of the last quarter, because there was a lot of discontinuities in the market, what we did was we went out and got about 90% of these securities priced externally, the ones that we couldn't get priced externally we got broker quotes on.

And then what we did was we did our own testing of those prices taking into account what we know about market spreads and we validated that taking into account external inputs on our models that the pricing that we got externally looked about right. So we're very comfortable what that is.

Josh Schmit - Crest

Just on that market external check. What is that and how does that relate to something like the AVX, which has deteriorated significantly? I understand the defaults or the ADX being only $20, etcetera or so.

Pat Kelleher

What that is as we go out and have a third party service solicit or get market data on observable trades. Where there are observable trades that are determined not to be stress scenarios we use that data for market.

We also have that service compile observable market inputs for securities where there haven't been trades, but where there have been trades in similar classes of securities and then we use those market inputs for calculating market values.

That's all done for us and that's how we value 90% of the portfolio that we have. And then we go and use our own models to validate that. Our own models will take into account what we know about securities and what we can see in the AVX spreads as of the date of the valuation.

And we do a check to make sure that the external pricing is in-line with what we can see as a reasonable best estimate of market value. And I can tell you that as of the 30th of September, those external market prices we got validate to our models reasonably well which is why we're comfortable with it.

Josh Schmit - Crest

Any material deterioration from that point to today?

Pat Kelleher

I don't know about that point to today, but what I can say is that the market values at the very high tranches are holding up very well and it's really the securities and the A and BBB where you've seen the deteriorations that are contributing to the kind of market to amortized cost comparisons, I referred to earlier.

Josh Schmit - Crest

Great, thanks. I'll follow-up on the captive. Thanks.

Operator

Your next question comes from the line of James Allan with Cgriff (ph). Mr. Allan your line is now open. There is no response from Mr. Allan.

Your next question comes from the Andrew Brill, with Goldman Sachs.

Andrew Brill - Goldman Sachs

Just a few questions here. I guess just the first question on the international front. I mean S&P originally suggested it may cut the ratings of a couple of hundred residential mortgages in Australia related to concerns -- related to PMI's issues in the U.S. and PMI's rating issues in particular. Just a question, are you seeing any opportunities to pick up some share in Australia due to those rating issues?

Mike Fraizer

Tom, do you want to take that?

Tom Mann

Andrew, that's a good question and I'm trying to think about how I answer it carefully? We continue to work to penetrate our global markets and one of the things that we do sell as part of our selling equation is our long-term risk management and stability issues. And we will continue to leverage that in not only support of Genworth but also be very careful to support our industry as well.

Andrew Brill - Goldman Sachs

I mean. I guess just in terms of any definitive market share data do you have anything that you can really point to that suggests that you have been able to pick up some share?

Mike Fraizer

Let me give you two perspectives -- and this is Mike, Andrew. I mean one, we certainly continue to penetrate nicely in Canada when you look around the world. Number two is we were very large in Australia, so that has been relatively stable to slightly down in share as we've seen a little more competition.

But I've traveled around to almost every market since August and, as you can imagine, you get asked a lot of questions such as yours. And you get asked that by your, A, your bank customers as an example and, B, by regulators who say what happened in the U.S. and how can we make sure it doesn't happen here.

So I'd give you this perspective which is I think while the U.S. market situation is certainly an unfortunate situation, it actually helps our international position in particular in the mortgage insurance line.

Because, A, how we've executed and how we've conveyed being a growth partner, a risk management partner, a capital management partner and basically a liquidity facilitation partner because you're putting on a credit risk mitigant that then with things going to the securitization markets is validated.

And people say we know what you say can be trusted and it makes a lot of sense and you're not going to try to get us into products that don't make sense for our market. So, that certainly helps you from credibility and a long-term partner standpoint.

Certainly we feel good about our capital levels. I can't judge comments in the market about others on that front. But, with the regulators, they have the same interest to saying how do we prevent some of the types of things that happened in the U.S. from happening in their market.

And in particular that was for some potential new competitors their entry strategy is to go to those riskier products, to go with some of these what I'll call exotic payment terms and that door is being shut and that is an opportunity for us to drive our business around the world with the teams on the ground that we have.

Andrew Brill - Goldman Sachs

That's thanks very helpful. And I guess just one more question. I just wanted to clarify on the excess capital front what drove the increase to the expected $900 million figure a year and up from prior estimates of $400 million and $600 million? Does that -- Did the old number exclude the release of capital from the MI or was there’s something else driving it?

Mike Fraizer

Pat, do you want to take that, please?

Pat Kelleher

Sure. The old number actually included a big portion of the dividend that we received from MI. I would characterize it as -- just as part of managing our business. We have an ongoing risk management initiative and a series of capital management projects.

And we're kind of just realizing better than expected opportunities as opposed to as a function of our risk management and our capital projects.

Andrew Brill - Goldman Sachs

Was it related to any particular business or just an overall --?

Pat Kelleher

It's fair to say it relates to all of our businesses.

Andrew Brill - Goldman Sachs

All right. Thank you.

Operator

Ladies and Gentlemen: we have time for one final question. Your final Question comes from the line of Mark Finkelstein, FPK.

Mark Finkelstein - FPK

Hi. Good morning. I'll ask a couple of quick questions. You've given some thoughts on '08 USMI earnings. I'm curious if you could give us any thoughts or direction on paid loss expectations?

Kevin Schneider

Mark, this is Kevin. We're not going to provide any guidance on that at this time and perhaps we'll be able to provide some new viewpoints on that at our December 11th strategic update.

Mark Finkelstein - FPK

Okay. And then I guess just thinking about the broader USMI market with some of the dislocation among some of your peers, I guess are you seeing any additional opportunities and do you have any thoughts or views on if one of them were to be downgraded what would be the opportunity or the impact to you?

Mike Fraizer

Well, this is Mike. We're not going to speculate on other situations that could be external to us. The fact is, as Kevin said, it's the market growth that's up over 60% and we're going to pick the spots within that that we think make sense for us. We've got the capital, the people, the products and the service to deliver on that and that's where we'll remain focused.

Mark Finkelstein - FPK

Okay. And then I guess just moving to Canada real quick. Losses have trended pretty favorable, I'm just curious how losses have trended relative to your own expectations and how do you see that block the loss experience seasoning going forward?

Tom Mann

Mark, this is Tom. The losses have seasoned reasonably consistent with what you would expect from our book development in that market. They've actually seasoned better than we expected that they would. And in short answer to both of those is we're well below pricing there as we see those books roll through.

As we look on a going forward basis we do expect a slowdown in home price appreciation in Canada. I would expect some economic slowdown as well driven primarily by the weakness in the United States dollar.

There is a lot of export business, export concentration in Canada and the current Dollar -- the current Canadian dollar stays as strong as it is we're going to have to be very thoughtful about that.

But net, net we have some excellent heavily home price embedded books of businesses. It reflects the beauty, if I could use that term with you, on the single finance premium product as we move forward and we're well positioned. We believe, for those books to perform very, very well. And as Mike indicated to you earlier, we continue to penetrate that market. So we feel very good about it.

Mark Finkelstein - FPK

Okay, good. Thank you.

Tom Mann

You're quite welcome.

Operator

I would now like to turn the back over to Alicia Charity for closing remarks.

Alicia Charity

Thank you and thank you for your time this morning. I realize we did run a little bit over. I will be available throughout the day to answer any questions that weren't answered on the call. And again, think you very much.

Operator

Ladies and gentlemen, this concludes Genworth Financial's third-quarter earnings conference call. Thank you for your participation. At this time the call will end.

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Source: Genworth Financial Q3 2007 Earnings Call Transcript
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