|Shares Out. (in M):||503||P/E||0||0|
|Market Cap (in $M):||1,828||P/FCF||0||0|
|Net Debt (in $M):||1,843||EBIT||0||0|
|TEV (in $M):||3,671||TEV/EBIT||0||0|
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Company: Genworth Financial, Inc. (GNW)
Trade 1: 6.50% Senior Notes, due 2034 at 88 (7.9% YTM) target 101 (19.4% 1 year return)
Trade 2: GNW Equity at $3.60 (deal close at $5.43, 51% return)
Credit Rating: B (S&P) / NR (Moody’s)
Event: GNW acquisition by China Oceanwide.
China Oceanwide is in the final steps of acquiring GNW in a deal spanning several years. The last step is approval by the NY insurance regulator. GNW and China Oceanwide recently announced they were delaying the 3/31/20 deal termination deadline as regulatory approval is hampered given an approval workforce slowdown driven by the corona crisis to 6/30/20. Press release indicates the deal is near completion and once completed, GNW’s entire structure is expected to re-rate inside mortgage insurance peers MTG (MGIC Investment Corporation) and RDN (Radian Group Inc) post-capital infusion with the equity currently priced at $3.60 to close at $5.43.
In a no-deal scenario, the company has cash on hand post the sale of the Canada subsidiary to pay down near term debt. Downside protection in provided by a SOTP analysis that includes: 1) the company’s stake in public Australian subsidiary (Genworth Mortgage Insurance Australia Ltd) as well as the 2) continuing mortgage insurance business, with 3) zero value given to the Life Insurance and Long Term Care business. In a worst case scenario, all bonds are covered at par however the equity does require the deal to close else the mid-case assumes a $2.50 price compared to the current $3.60 price (or a downside or $1.12 compared to an upside of $1.80 for a 1.6x upside/downside ratio with a high probably of the deal closing).
Genworth Financial, Inc. (the company or GNW) is a 2004 spin from GE capital and offers insurance products in 3 business lines:
· Mortgage Insurance (MI) – GNW provides mortgage insurance in the US and in Australia. The company’s sub-segments are healthy and growing.
o Business in US is done by a US Mortgage Insurance subsidiary located in North Carolina.
o Business in Australia is conducted via its publicly listed subsidiary, Genworth Mortgage Insurance Australia Limited (GMA AU Equity), where GNW owns 51.95% of the $567.2MM market cap listed company.
· Long-Term Care (LTC) – Even though this US business is structurally separated, the business line is challenged creating an earnings drag and an overhang for the overall company.
· Life Insurance – While this US business is healthy, the segment is structurally owned by the LTC business resulting in limited residual value for GNW. The business line is currently in runoff.
· China Oceanwide Holdings Group Co., Ltd. (Oceanwide or China Oceanwide) Transaction – Pending
o Announced: 10/23/16
o Closed: Pending (target date: 06/30/20)
o Deal details:
§ GNW to be acquired for $5.43/share or $2.7bn in EV.
§ China Oceanwide to invest $1.5bn of equity into GNW’s holding company (Genworth Holdings, Inc), with proceeds used to retire GNW near term debt and drive future growth.
· $500MM is expected to be contributed within one month of deal closure.
· $1bn to be contributed by the end of 2020.
§ Post capital contribution by China Oceanwide, Genworth Holdings to contribute $175MM of capital to GLIC (Genworth Life Insurance Co).
§ GLIC to then issue to GLAIC (Genworth Life & Annuity Insurance Co) a $200MM promissory note to improve GLIC liquidity to $375MM ($175MM capital contribution + $200MM note).
o Approvals needed:
§ State insurance regulators in New York, Virginia and Delaware. All three are expected to be approved post- New York approval.
· Brookfield Business Partners LP – Closed
o Announced: 08/13/2019
o Closed: 12/12/2019
o Deal details:
§ Genworth Financial Inc sold Genworth MI Canada Inc to Brookfield Business Partners LP for CAD 2,391.44M ($1.8bn).
· Proceeds ($885MM) used to pay down outstanding TL and 2020 notes, with remaining cash held for future debt payments.
§ Canadian asset sold due to lack of progress in obtaining Canadian Regulatory approval for the China Oceanwide transaction.
Valuation – Sum of the Parts (SOTP)
Senior debt has a fully recovery under all scenarios as indicated below. The below SOTP is as of today and does not assume the addition $1.5bn of equity invested into Genworth Holdings, with proceeds used to retire near term debt and fund growth opportunities.
Valuation – Relative Valuation
MTG (MGIC Investment Corporation) and RDN (Radian Group Inc.) are mortgage insurance peers to GNW’s MI business. Post-Oceanwide transaction, the bonds are expected to re-rate closer in-line with peers as capital is injected into GNW. An illustrative showing below demonstrates the impact to GNW 2034s.
Capital Structure & Financial Review
Consolidated Financial Review
GNW operates under 4 principal segments
· US Mortgage Insurance
· Australia Mortgage Insurance
· US Life Insurance Segment: Includes Long term care insurance, life insurance, and fixed annuities
· Runoff: Includes variable annuities and other product categories GNW is exiting
US Mortgage Insurance
Mortgage insurance is insurance paid by a borrower, which pays out to the lender should the borrower default. It can be purchased with a single premium at the time of lending, or with annual premiums. Note that mortgage insurance rarely covers the full value of the mortgage (usually only 10%-40%), as this would be overkill, as the mortgage is secured by the property to begin with. Fannie Mae and Freddie Mac will not guarantee mortgages with LTVs higher than 80% unless the borrower has purchased mortgage insurance, resulting in most mortgages with LTVs higher than 80% having mortgage insurance. Mortgage insurance is less common on mortgages with lower LTVs.
The market is divided between the Federal Housing Administration (FHA) and private mortgage insurers. As of 2016, the FHA accounted for 37% of new premiums written, primarily catering to those with lower credit scores. Market share of new premiums written in the private market in 2016 was: United Guaranty (18.8%), Mortgage Guaranty (18.2%), Radian Guaranty (18.1%), GNW (16.2%), Essent Guaranty (12.1%), Others (16.6%).
The mortgage insurance market was pulverized during the GFC, but as the economy recovered and mortgage default rates fell, the market has become lucrative once again.
Mortgage insurers primarily market their products to lenders, not borrowers, even though borrowers are the eventual end customer. Lenders decide who they want to insure their loans, and then make these offerings available to borrowers at the time of lending. Lenders will generally work with multiple mortgage insurers.
32% of GNW’s new insurance written came from its top 5 lender partners.
Insurance in Force refers to the gross value of mortgage loans on which GNW is currently providing insurance. As GNW does not insure the full value of the loan, GNW’s potential liability is much less than this. Risk in Force refers to this liability, the actual principal which GNW is insuring, and is the theoretical amount GNW would have to pay if every insured loan defaulted.
Revenues are primarily composed of insurance premiums. Note that when insurance is purchased with a single up-front premium, GNW recognizes this revenue by amortizing this payment over the term the insurance is provided. Costs are primarily benefits paid to lenders and OPEX, which includes marketing and commissions. Note that certain up-front acquisition costs are deferred over the term insurance is provided. The expense ratio measures OPEX relative to premiums. The loss ratio measures benefits paid relative to premiums.
GNW has seen strong growth in Insurance in Force, driving Risk in Force, driving premiums. Lower defaults have dramatically lowered benefits paid, boosting NI. In 2013 the delinquency rate on Insurance in Force was 8.2% causing a loss rate of 74%. In 2019 the delinquency rate had fallen to 1.9% yielding a loss rate of only 6%. There has been minimal leverage on OPEX, and the expense ratio has stayed roughly flat.
Australia Mortgage Insurance (Publicly Traded, Fully Consolidated)
The fundamental mechanics of Australia Mortgage insurance are the same as the US, although there are some differences. In Australia, almost all insurance is purchased with a single up-front premium (which GNW then amortizes), and insurance generally guarantees the entirety of unpaid principal on an insured mortgage. Mortgage insurance in Australia is often called Lenders Mortgage Insurance (LMI).
GNW and QBE are the two largest players and together account for 64% of premiums written. The reminder of the market is taken by captive players, primarily Westpac and ANZ.
GNW’s 3 largest lending partners account for 60% of insurance written.
While the US market has been improving, the Australian market has been weakening, albeit from strong base. Note the negative premiums in 2017 was due to an adjustment of the amortization rate of the single up-front premiums.
It is not important for the write-up, but pricing in Australia is much lower than in the US, and I don’t understand why. A delinquency rate of 0.5% is driving a loss rate of 33% in Australia, while a 1.9% delinquency rate is only driving a 5.8% loss rate in the US. This is particularly weird given that the US is much more competitive, and everyone is worried about pricing.
US Life Insurance Segment
The US Life Insurance segment is composed of three products: Traditional Life Insurance, Fixed Price Annuities, and Long Term Care (LTC) Insurance. In 2016, GNW suspended sales of Traditional Life and Fixed Price Annuities, but new LTC Insurance policies are still sold, and will continue to be. As LTC Insurance makes up the bulk of the US Life Insurance segment, the segment must be considered a going concern, even if it is low growth.
LTC insurance is insurance which provides coverage for the costs of long term care, primarily nursing homes and other assisted living arrangements. It is offered under varying parameters (whole life or term, higher/lower deductibles, higher/lower/no max benefits).
Measuring outstanding liability is difficult as many plans do not have defined benefits. We can track issuance via In Force Lives (the number of people covered by plans), or the PV of future benefits less PV of future premiums. The latter is of limited usefulness though, given it is based on management assumptions. From 2013 to 2019 GNW saw its PV of future benefits less PV of future premiums grow from $17bln to $26bln. This was not from issuing large numbers of new polices though. The grow was simply from management recognizing that currently in force polices actually had much higher liabilities than initially estimated.
For LTC insurance, GNW calculates the expense ratio and loss rate including both premiums and investment income. While they do not state this explicitly, I assume this is due to LTC insurance being longer dated than mortgage insurance, and so reinvested premiums are a material and necessary component of paying the required benefits.
Long Term Care sales are low today. This is largely because of poor pricing in the past, causing
1. GNW today to focus on raising rates/lowering benefits on in force policies (something that requires lengthy legal approval, and as you can expect, politically unpopular to allow)
2. Third party LTC distributors (who are the primary sales channel) to stop working with GNW due to their poor performance on past products and poor current financial ratings.
âNote that while GNW has not suspended LTC sales totally, they have stopped new sales in several states.
Below shows GNW activity on rate increases. They have made some headway, but note that current estimates of the PV of future benefits less PV of future premiums from current policies in force bake in yet unapproved rate increases. Thus, the current liability on the balance sheet could potentially become much larger.