Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Genworth Financial, Inc. (NYSE:GNW)

Q3 2007 Earnings Call

October 26, 2007 9:00 am ET


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


Jimmy Bhullar - JPMorgan

Nigel Dally - Morgan Stanley

Steven Schwartz - Raymond James

Bob Glasspiegel - Langen McAlenney

Andrew Kligerman - UBS


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

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

Alicia Charity

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

We also posted updated investor materials on our insurance business to reflect third-quarter results. This morning youwill 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 fora question-and-answer period. Pam Schutz, Executive Vice President of ourretirement and protection segment; Tom Mann, Executive Vice President of ourinternational and U.S. Mortgage Insurance segment, and other business leaderswill be available to take your questions.

With regard to forward-looking statements and the use ofnon-GAAP financial information, some of the statements we make during the calltoday may contain forward-looking statements. Our actual results may differmaterially from such statements.

We advise you to read the cautionary note regardingforward-looking statements in our earnings release or the risk factor sectionof our most recent annual report Form 10-K filed with the SEC and in our Form8-K filed with the SEC on April 16, 2007.

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

And finally, when we talk about our international segmentresults, please note that all percent changes exclude the impact of foreignexchange. 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'llprovide an overview perspective on the business, what's going well and where wesee challenges. Then Kevin Schneider will discuss the U.S. mortgage insurancebusiness. I will note that we made $39 million in the quarter in this businessline, a testament to our risk management practices. And finally, Pat Kelleherwill talk about overall quarterly results and our earnings outlook.

Let me start with parts of the business where I think we'rehitting on all cylinders. First, our international business continued todeliver strong earnings growth and represented 35% of net operating earnings inthe quarter. Importantly, we have strong sales momentum and a growing globalpresence.

In our established platforms we are penetrating ourcustomer's value chain through strong product offerings and differentiatedservice and we are prudently growing our global footprint, taking productexpertise in payment protection and mortgage insurance to new internationalmarkets.

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

We're also making good progress in our life franchise inparticular growing our position in the universal life market. The insurancebrokerage channel, where we have a leading position, is transitioning toselling more universal life, relying less on term life and we are leveragingthat.

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

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

Captive reinsurance coverage on just over 60% of our bookprovides a nice backstop to absorb a significant level of losses that maydevelop. 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 andunder weighting California.

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

I also think the rapidly expanding market for mortgageinsurance in the U.S. is a real plus. The new business layers being generatedfrom late 2007 forward should demonstrate strong profitability and we arecomfortable 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 infour areas, U.S. housing market dynamics, how Genworth is positioned, thetremendous revenue opportunity and, finally, our outlook for U.S. mortgageearnings.

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

So as teaser rate resets drove defaults and contributed to aliquidity crisis, not only did we see impacts in the subprime markets, weexperienced adverse trends in alternative products and saw a contagion effectmore broadly as increased housing inventory caused regional declines in homeprices.

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

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

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

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. Weexpect significant variation among MSAs; in areas such as Naples, Florida orSanta 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 modestincreases in home prices.

Turning to losses in the quarter, paid claims remainedwithin our forecast and we had a $75 million net increase to reserves primarilyfrom increased delinquencies in Florida, California, Arizona, Nevada and, to alesser extent, the Great Lakes, along with the alternative products such asAlt-A and A Minus.

Genworth remains aggressive in working with borrowers andservicers to restructure, modify or workout delinquent loans and we have over 80people dedicated to doing just that. Turning to performance by book year, our2004 and prior books continue to perform better than pricing, driven byseasoning and embedded home price appreciation.

We believe our 2005 and '06 books will perform above targetedloss expectations. Although early the first half of '07 should perform morelike '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 reinsuranceand we expect them to attach. These are lender-by-lender agreements and willattach on a lender-by-lender basis.

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

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

As we look to 2008 we will continue to drive revised productand underwriting standards in response to market conditions and we are workingclosely with the GSEs and our lenders to ensure the market in 2008 and beyondis characterized by products that better address both consumer and riskmanagement needs.

The great news is that the top-line growth dynamics formortgage insurance are strong and we see this continuing in the years ahead. Inthe first nine months of '07, while mortgage originations are down an estimated12%, we believe the mortgage insurance market has grown almost 60% or $75billion. 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 shiftingto fixed products, reporting strong high-quality growth in mortgage insurance.Simultaneous seconds have dropped to about 22% of the market and GSEpenetration in the mortgage-backed security market is also up sharply,estimated at over 70% this quarter. The strong flow mortgage insurance marketgrowth and our selective participation in prime bulk transactions has resultedin revenue growth of 22% on a year-to-date basis.

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

Looking to the fourth quarter, we expect revenue growth andexpense productivity to partially offset a continued increase in losses. Whilewe are adding more to reserves than originally anticipated, we expect to endthe year with earnings in the $170 to $200 million range. We expect 2007 paidclaims 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 supporttargeted business growth during this period of higher losses. This quarter weworked closely with our regulators and the rating agencies to extract $300million of excess contingency reserves and executed a $350 million dividend tothe holding company.

We remain committed to maintaining our AA ratings and webelieve we have the capital to both handle the current loss cycle and fundgrowth. Looking ahead to 2008 we expect earnings at or modestly below the 2007level and we will provide additional detail on earnings and capital planning onour 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 ofrecent volatility in financial markets on Genworth, third, I'll cover financialtargets including expenses, taxes and capital management, and then I'll wrap upwith our outlook.

Let's start with the international platforms where operatingearnings were up 20% on an FX adjusted basis. Canada delivered stellarperformance with flow NIW up 27% both from growth in the high loan to valuemarket and from market penetration. The loss ratio in Canada at 18% remainedstrong and consistent with our expectation that the loss ratio will season overtime following a period of very low loss experience.

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

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

We saw similar growth in universal life insurance as ourbrokerage channel transitions to selling more of this product, offsetting thedrop in term life sales where competition is steep. Universal life no lapseguarantee product sales were strong as were sales of large case policiesreflecting our increase in per policy retention last year.

Long-term care sales also showed nice growth largely fromour life and long-term care combo product and from strong growth in careeragency sales. Independent channel sales were slightly below last year but upabout 11% adjusting for the sales pickup ahead of last year's new businessprice increase in California.

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

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

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

Finally, recent financial market conditions have favorablyimpacted our international results. U.S. dollar declines against the Canadiandollar, 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. Andfinally, foreign exchange contributed $12 million to earnings for the quarter.

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

On a full-year basis we're on track to deliver our objectiveof an effective tax rate close to 29%. On the capital front we completed our1.1 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 apayout range of at least 11% to 12%.

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

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

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

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

Question-and-Answer Session


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

Jimmy Bhullar - JPMorgan

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

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

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

And the strong sales growth over the last few years was notpartly because of aggressive pricing and whether you feel comfortable with themargins in that business long-term? And that's all I have.

Mike Fraizer

Thanks, Jimmy, two great questions. Let me start with thefirst and I'll give it to Bill, goings on the life question second. Certainlywhen 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 onan '08, but a multi-year basis, and of course capital deployment is part ofthat. We will make sure that we can fund what are very strong core growthopportunities such as in our retirement lines, international lines.

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

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

So we'll be very thoughtful and certainly consider that, andthat we've had a track record of balancing all four levers in capitaldeployment. 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 atwith excess capital?

Mike Fraizer

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

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

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

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

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

Bill Goings

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

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

Secondly, you referred to the growth. I feel verycomfortable with the overall sales this quarter as it relates to the lifebusiness. Again, the term market is very competitive where you see us actuallydeclining in sales.

But our strong progress in universal life is really due tothe fact that our primary distribution is headed that way. We have verycompetitive no lapse guaranteed products. We've enhanced our capability aroundwholesaling, 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 andvery comfortable with the overall growth profile for this business.

Jimmy Bhullar - JPMorgan

Thank you.


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

Nigel Dally - Morgan Stanley

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

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

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

Mike Fraizer

Nigel, let me give it over to first Kevin Schneider, whowill hit on both the first two questions and then I'm going to give it to Tomto 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 therange 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 billionnext year we're reflecting the high levels of persistency and the continuedstrong mortgage insurance market that we have right now.

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

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

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

Mike Fraizer

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

Kevin Schneider


Mike Fraizer

Capital extraction plan?

Kevin Schneider

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

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

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

Mike Fraizer

Tom, do you want to pick up on Australia?

Tom Mann

Sure, Nigel, thanks for the question. The first thing Iwould 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 excellentrevenue growth to offset increased losses that you alluded to.

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

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

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

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

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

Nigel Dally - Morgan Stanley

Great, thank you.


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

Steven Schwartz - Raymond James

Nigel just asked a bunch of them, but Kevin, could you justwalk 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 andwhen 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 thinkabout delinquencies, generally your delinquencies hit their peak about twoyears following, two to three years following, three years following theorigination of that book depending on how the book feathers in. And then yourultimate claims speak about a year later.

So, if you think about our books right now, our 2003 bookhas 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 ofits delinquency levels with claims feathering in through next year.

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

Steven Schwartz - Raymond James

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

Kevin Schneider

Captive reinsurance agreements and let me give you anexample of a common structure in the industry, which is called a 40 excess ofloss agreement. In those agreements, when losses achieve 4% of the originalrisk in force of that book. Then at that point, the captive attaches itsattachment point.

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

Steven Schwartz - Raymond James

Okay, great. Thank you very much, Kevin.


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 mortgagedisclosure. As I look at page 5, it looks like your '07 vintages have thehighest loan to value and the worst FICO scores.

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

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

Kevin Schneider

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

Bob Glasspiegel - Langen McAlenney


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 thatwas actually probably begun to be originating in the latter part of '06 andthen spillover into 2007.

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

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

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

Bob Glasspiegel - Langen McAlenney

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

Kevin Schneider

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

And FICO scores will be impacted somewhat because we'regoing to have – we have pulled back on some guidelines and are restricting someof 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 thinkas 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 theoriginal loan to values that we will be underwriting.

But at the same time, if we have continued housing declinesnext year, that will serve to offset that benefit. But we're going to try tomanage that effective loan to value down as effectively as we can. And on theFICO scores as well, earlier in the year when you saw the massive liquiditydrain in the sub-prime market of some of that business began to flow backthrough 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 closelywith both Fannie Mae and Freddie Mac to ensure that we are developing andinsuring and therefore in their guaranteed business and portfolio responsibleconsumer products.

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

Bob Glasspiegel - Langen McAlenney

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

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

Mike Fraizer

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

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

Bob Glasspiegel - Langen McAlenney

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

Mike Fraizer

Yes, we're comfortable with the reserves and, again, we'reputting in the additional margin. I think from that margin perspective you'llstart seeing premium coming gradually through '08 and you get by the end of '08and 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.


Our next question comes from the line of Andrew Kligermanwith UBS.

Andrew Kligerman - UBS

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

Mike Fraizer

Kevin, do you want to pick that up?

Kevin Schneider

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

And what that is average median home price for the totalyear of '08 over the total year of '07. I think a better way to think about itand the way we think about it when we look at our books is really on asequential basis and if you sort of go from peak to trough at the highwatermark 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 viewagain out of the forecasting is about 2% further decline in '08.

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

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

But again, some default rate is a function of both defaultsas well as policies in force, and we expect we didn’t have strong policy inforce growth as well, so that will continue to moderate that, but you're goingto 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'ssort of where it stops, the default rate?

Kevin Schneider

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

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

Mike Frazier

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

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

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

So, what we're going to do is similar to what we did inAugust and probably early next week is put out some other ways the investorcommunity 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 onour website as we did in August and I think we'll get a similar favorablefeedback.

Andrew Kligerman - UBS

Yes, that would definitely be helpful. And just to kind ofwrap 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 ordoes it get a little higher in 2010?

In other words, when do you think these rough vintages aregoing 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 thatin 2010?

Mike Frazier

I'll give you two perspectives. One is the general rule ofthumb 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 westill see consistent with the vintages of books that we have right now.

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

Andrew Kligerman - UBS

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

Tom Mann

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

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

We're going to see that again this year, which is veryhealthy 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 homeprice appreciation.

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

And while they have had some interest rate increases, Ithink about four since mid of last year, again to we've given some inflationaryconcerns and again some acceleration in housing finance concerns, they continueto manage it very, very well and we remain very comfortable with thatenvironment.

Andrew Kligerman - UBS

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

Tom Mann

Well, It is about 30% to 35% of the total portfolio, butwhat 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 thinkmy numbers are directionally correct that is where you have had a little bitless, you have had some home price deterioration, I should say, and lessappreciation.

Andrew Kligerman - UBS

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

Tom Mann

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


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

Ed Spehar

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

Obviously, the favorable top-line outlook in the MI business,Mike, putting those two together, the comments you just made suggest that weshouldn'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 offsetthis seasoning, is that without, kind of forcing you to give us a number.

I just want to know if conceptually that is how we shouldthink 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 evenmore visibility as we look forward.

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

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

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

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

And that is causing the multiyear dynamics and whateffectively are the distortions of loss ratios that's there. What I amsuggesting in the case of Genworth is we have a more predictable path ofrevenue growth.

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

And, in fact, some of that is going to ramp up as theselayers have come on. And as you get into '09, you have more opportunity forthose revenue dynamics to stand out, in relation to the progression and normalseasoning and increasing of losses.

Again, we want to give you some more visibility, but that iswhere 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 peopledon't understand that well. You’ve seen our tutorial efforts on it. We're goingto give some more and some additional disclosures.

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

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

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

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

Ed Spehar - Merrill Lynch

Okay. And just a follow-up and I guess opportunity doesn'tsound like down, I guess, I would say. In terms of Australia and Canada, giventhe reliance on natural resources based types of economies. How do you thinkabout the impact that changes in commodity prices would have on home priceappreciation outlook? How do we price for and make sure we don't have ascenario 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 yoursecond part of that question first and then answer your question on thecommodity, if you will, dependency to the countries. I think, when we think ofall of the global markets today and we need to remember that particularly froma mortgage perspective, they are very, very dissimilar from what that’shappened in the United States.

You have very -- when you look globally with the possibleexception of the United Kingdom, you have fundamentally nominal amounts ofsub-prime and non-prime mortgage originations. Thus, remember in the UnitedStates in '05 and '06, we had about 40% of our originations were in those typeproducts.

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

Therefore, if you think about it from a liquidityperspective, which again was the second part of your question, there is simplyno real comparable liquidity issues in the global mortgage markets.

Now, the global markets are indeed being impacted to adegree, continue to be impacted by the broad liquidity issue as it relates tothe 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 andthen all of our markets, I would categorize them outside the United States assimply more traditional. And by that, we have had strong home priceappreciation because of our low historical interest rates, strong economies, inmany parts driven by the commodity dependency on both Canada and Australia andalso by excellent housing demand.

So, when I think about these economies going forward, wewill 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 priceappreciation trends in those areas that have benefited from those facts thatyou've mentioned that would be Western Canada and also Western Australia.

We manage our loan-to-value concentrations in thoseenvironments and then we watch them for how these respective governments aregoing to manage the downturn or the flattening out that will occur in homeprice appreciation, by the way, which will inevitably occur.

So while there is a degree of dependency on both thoseeconomies on the commodities markets, we are hopeful that it will be monitordown very carefully. But I don't see anything that will happen there that iseven roughly similar to the very unique situation that we have in the UnitedStates markets.

Ed Spehar - Merrill Lynch

Thank you. That is very helpful.


Your next question comes from the line of Josh Schmidt withCrest.

Josh Schmit - Crest

Hi, thanks for taking the call. A quick question on thelong-term ROE from the cap, because I think you mentioned that 10 to 12 is justsort of a floor. Can you kind of walk through the math? Others have said thesame thing, but it appears that if it went bad really, really fast you'd earnenough premium over time to offset that. So if you could walk through that a littlebit 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 wayto 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 anROE basis up until the point at which you do hit that attachment. Once you hitthat 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 theimpairments of the?

Mike Fraizer

Josh, just remember, we don't expect to come out the otherside 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 theirinvestments and CDOs. I think, HARTFORD took some on their order; Merrillobviously, took massive hits. What is your process for determining whetherthose assets are impaired or not?

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

Pat Kelleher

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

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

Josh Schmit - Crest

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

Pat Kelleher

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

And over the course of the last quarter, because there was alot of discontinuities in the market, what we did was we went out and got about90% of these securities priced externally, the ones that we couldn't get pricedexternally we got broker quotes on.

And then what we did was we did our own testing of thoseprices taking into account what we know about market spreads and we validatedthat taking into account external inputs on our models that the pricing that wegot 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 howdoes that relate to something like the AVX, which has deterioratedsignificantly? I understand the defaults or the ADX being only $20, etcetera orso.

Pat Kelleher

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

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

That's all done for us and that's how we value 90% of theportfolio 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 wecan see in the AVX spreads as of the date of the valuation.

And we do a check to make sure that the external pricing isin-line with what we can see as a reasonable best estimate of market value. AndI can tell you that as of the 30th of September, those external market priceswe got validate to our models reasonably well which is why we're comfortablewith 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 sayis that the market values at the very high tranches are holding up very welland it's really the securities and the A and BBB where you've seen thedeteriorations that are contributing to the kind of market to amortized costcomparisons, I referred to earlier.

Josh Schmit - Crest

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


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

Your next question comes from the Andrew Brill, with GoldmanSachs.

Andrew Brill - Goldman Sachs

Just a few questions here. I guess just the first questionon the international front. I mean S&P originally suggested it may cut theratings of a couple of hundred residential mortgages in Australia related toconcerns -- related to PMI's issues in the U.S. and PMI's rating issues inparticular. Just a question, are you seeing any opportunities to pick up someshare 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 abouthow I answer it carefully? We continue to work to penetrate our global marketsand one of the things that we do sell as part of our selling equation is ourlong-term risk management and stability issues. And we will continue toleverage that in not only support of Genworth but also be very careful tosupport our industry as well.

Andrew Brill - Goldman Sachs

I mean. I guess just in terms of any definitive market sharedata do you have anything that you can really point to that suggests that youhave 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 whenyou look around the world. Number two is we were very large in Australia, sothat has been relatively stable to slightly down in share as we've seen alittle more competition.

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

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

Because, A, how we've executed and how we've conveyed beinga growth partner, a risk management partner, a capital management partner andbasically a liquidity facilitation partner because you're putting on a creditrisk mitigant that then with things going to the securitization markets isvalidated.

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

Certainly we feel good about our capital levels. I can'tjudge comments in the market about others on that front. But, with theregulators, they have the same interest to saying how do we prevent some of thetypes of things that happened in the U.S. from happening in their market.

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

Andrew Brill - Goldman Sachs

That's thanks very helpful. And I guess just one morequestion. I just wanted to clarify on the excess capital front what drove theincrease to the expected $900 million figure a year and up from prior estimatesof $400 million and $600 million? Does that -- Did the old number exclude therelease 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 thedividend that we received from MI. I would characterize it as -- just as partof managing our business. We have an ongoing risk management initiative and aseries of capital management projects.

And we're kind of just realizing better than expectedopportunities as opposed to as a function of our risk management and ourcapital 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.


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 giveus any thoughts or direction on paid loss expectations?

Kevin Schneider

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

Mark Finkelstein - FPK

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

Mike Fraizer

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

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 trendedrelative to your own expectations and how do you see that block the lossexperience seasoning going forward?

Tom Mann

Mark, this is Tom. The losses have seasoned reasonablyconsistent 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 shortanswer to both of those is we're well below pricing there as we see those booksroll through.

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

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

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

Mark Finkelstein - FPK

Okay, good. Thank you.

Tom Mann

You're quite welcome.


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

Alicia Charity

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


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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!

This Transcript
All Transcripts