Saturday, October 30, 2010

The Genworth Conference Call

This is a must read... Steven Eisman is one of the traders who was featured in The Big Short for recognizing the the housing bubble (and making money off the bust).

Steven Eisman - FrontPoint
Yes, hi. I think it’s pretty clear, this was a very poor quarter, but there are larger issues here that I think you need to address. Frankly the only accomplishment that this management’s team contribute point to is the survival of this company which I don’t mean to minimize, but otherwise this management team has overseen a massive destruction of shareholder value. In fact at the current price to book Genworth is selling at a steep discount to both MGIC and PMI, the pure-play MIs. This is probably because this company does not meet its cost of capital and any of its businesses.

In other words, the market currently is describing negative value to your non-MI businesses. A pretty astonishing statement and I don’t get any sense of urgency from this management’s team as to how this is all going to be addressed. To keep going down the current road seems to me a complete waste of time. Clearly, the best use of capital for this company is to buy back stock when it is at discount, less than 40% of book value. The ROE on that activity is multiple higher than any new business you can write.

So it seems to me, we can go down a couple of roads, number one, you could shutdown businesses and use resulting excess capital to buy back stock or you can give us a roadmap and the time schedule which we’re going to hold you too as to when each of your businesses will achieve at least its cost of capital. I want you to understand that my patience, but the patience of your shareholder is not infinite and my patience is just about done.

And I would like a response to my comments and one other thing, at the beginning of this conference call Mr. Fraizer said that they might do bolt-on acquisitions; do not do that. Your stock is selling at less than 40% of book value, you do a bolt-on acquisitions and I will wage a proxy battle immediately to throw you out of here. Now, I will like some response.
Mike Fraizer
Steve, you’ve touched upon a number of areas so let me walk through those. Clearly we are in a transition with different other business segments at different stages of that transition. As we look at the international segment, a much clear path, a much clear performance trend, you can also see the path to not only earning your cost of capital in international, but it’s, in fact, exceeding the net cost of capital and we’ll reinforce that as we layout both where we are and where we’re going in that as we walk through the Investor Day but I think you can see that in the numbers.
Steven Eisman - FrontPoint
I can’t but go ahead.
Mike Fraizer
If you look at international and where we have targeted in that segment, 15% ROE by 2012, we’re tracking right to that. So, we’ll try to make sure that in that forum, we can show all the details and leverage that you and other investors can see behind that one. Number two, if you get to the mortgage insurance business, clearly the transition we’re going through is a frustrating one and I share your frustration on that, but I think we’re doing all of the right things to bring that business back.

Now, I can’t explain for you the difference in valuation if I look at that on a segment versus some other public comparables. I’m happy to have that deeper discussion on the reasons for that. We have perspectives on that separately, but there is a business where we did move early and others followed to deal with loss mitigation activities to re-price business for the risk, so that as you put on new business you can churn that business.

We’re currently seeing a very choppy to say the least third quarter set of data come in as Kevin outlined that as I said that is a business we will again see transition back earning more than a cost of capital. I think we have a timing issue there given some of the factors I highlighted specifically in the market.

Thirdly, then you come back to Retirement and Protection and we have put a number of lines, such as our institutional area into run off to basically harvest capital from them. We do, as you look at capital there, have maintained capital to support the ratings and the sound level of growth not too much and too little, maintain appropriate risk offers and now I am jumping to a bit of an enterprise comment, optimize the capital structure as we look through the maturities we have in 2011 and 2012.

So let me just finish then on the Life business. We have to continue at the line levels taking the actions we are. We’ll show you the progress in Long Term Care and you’ve seen us move on with pricing actions there and the dynamics of the old book versus the new book. The old book is about 35% of the book. The new book is now at 65% in the path of those dynamics. The Life area, because of the two factors that the Pat has touched upon, has certainly have been below our performance expectations, but that’s also why we totally changed the nature of the product to not make it capital consumptive as the old and they have very different margins.

Now, let’s get to your point on the use of any excess capital and what’s the appropriate use of that. First, if I look at the map, for example and use $100 million to repurchase shares, you would get about 5 basis point lift on today’s ROE and I look at that quite carefully. I would agree with you that, first of all, acquisitions should not be a major priority or any subsequent priority for the company beyond what it’s executing with organic growth and optimizing our capital structure and maintaining appropriate risk buffers.

The one you did see this quarter was a small a tuck-in one, there is not a pipeline of those per se, but in the wealth management business that’s the one area I’d pointed towards along with where we’ve selectively put less than $25 million of capital looking at a few new markets in international mortgage insurance that we think can be the next Canada and Australia, but it has to be very modest, because after that, I would agree as I look at any excess re-deployable capital, the math is compelling on a share repurchase, when we look at the book valuation.

But right now if you step away and you look at our capital versus rating agency requirements or regulatory requirements, you’d see about a $1.2 billion level over those hurdles. We would hold basically if you look at U.S. Mortgage Insurance would hold the portion associated with that to navigate this period as a risk buffer. We would hold what we have in the Life business, similarly for both risk buffers and just to operate the business appropriately at a single A rating and the rest of that capital sits in the international.

As Pat as noted, there will be dividends that come in from international through the holding company, but some of those dividends will be used to address the 2011 and 2012 maturities and you’ll see our debt to capital structure come from sort of the mid 20 range, right down to the 20% to 21% range, which is in line with targeted coverage ratios and where we need to be. So, if there is capital that we generate beyond that as we go forward, your point due noted and accepted, that if you have that excess capital buying shares is a compelling way to deploy that capital and you should run your other businesses for recovery.

So, as we get to the December Investor Day we will certainly endeavor to walk you through with good visibility, not only each of those segments, but also the holding company, walk you through the levers and continue to take your views as well as other investor views and execute.

Our next question comes from Colin Devine with Citi.

Colin Devine - Citi
Good morning. I guess following-up on Steve’s comments, in one chance with respect to strategy I’m just going to leave U.S. MI alone, really not much more I can say about it. It seems to me that you’re in a lot of businesses where Genworth is at best a second tier player, if that; whether it’s variables annuities, I’m not sure why you continue to do it, I’m not sure what the incremental benefit long-term is going to be, if the credit insurance business where the earnings are the third of where they were two years ago. Isn’t the real strategy here that you need to shrink this company and focus on your key lines, whatever you decide those are, rather than playing in things like Wealth Management, where Genworth is never going to be a material player or it’s never going to contribute the material amount to earnings at least over the next five years?
Mike Fraizer
Alan, we’ve taken in some important steps I think to focus the company and you’re going to see that transition continue. I’ll just walk through. If you look at the Life and Long Term Care area, as we declared that we have leadership in both in the middle or mainstream market in Life Insurance and if you look at the bulk of our policies, they are under $1 million face size. In fact, the vast majorities were under 500,000 and we’re penetrating in both segments. So we’ve made a very clear call there and we’ve made a very clear call in making sure that we leverage our long term care experience. We have appropriate and profitable business there.

The wealth management business has actually grown nicely. I understand we can have different views, but that is third area that we concentrated on because of the shift to advisors and we’ve seen a lot of advisor dynamics moving to independent platforms that we serve. We have taken a much narrower stance and continue to evaluate the optimum participation in the annuity area, recognizing that some of our distribution values selling more than one product and that is a dialog with distribution.

We’re able to leverage our distribution expense and spread it because of those multiple products as opposed to if you are a monoline in that area. But there will be the appropriate capital give to the leadership areas and that capital has been taken away from the other areas as we work through that U.S. Life strategy, which is playing out but for the drag in the older blocks that Pat talked about, lapsing off dynamics around that.

Internationally, in Mortgage Insurance, I’m upset when you look at Canada and Australia and the way those platforms not only perform but move through and we pulled back from a number of markets we were starting to explore to concentrate on those leadership areas, while selectively planting some seeds. I guess we probably have a different view on the Lifestyle Protection business because of how we see the market and it sounds like we should make sure that we do a good job of laying that out. I view that overtime as more of a complement to a protection value proposition.

When you look at the nature of the risks, the underwriting, the actuarial support that we leverage and I like the diversification it gives you in the protection area versus the U.S. market. So I think it’s more than just being classified as a credit insurance business, but we will, as we move through, are executing our strategy. Of course, look at our portfolio and make sure that our portfolio mix evolves, so that not only are we trying to rebuild value but we optimize it over time. So we hope try to bring, certainly, I’ll say a diligent screen to where we put capital and where we don’t as we move ahead.

Colin Devine - Citi
Mike, I think you’re still missing the points Steve made, is you’ve got a lot of capital tied up and frankly, what I would refer to as many hobby businesses that just result in a complete lack of focus. I mean, managed money, Genworth is never going to be a player in, okay. In variable annuities, you are not and I guess it’s very difficult, I mean the market perceives you as a specialty writer if it’s in Long Term Care, perhaps Life. I don’t see why you need to offer variable annuity to complement that and even in Long Term Care, that’s a sector where most of, in fact pretty much all the majors have pulled out and if we look at the in force block, it’s clearly not earning target profitability since the day you bought Genworth public, every analyst meeting you’ve talked about getting it re-priced, right? We’re still here with having to put rate hikes up. If Long Term Care, is your core line maybe it needs a lot more attention and you need to get out of some of these other businesses, pay down the debt and strengthen this balance sheet.

Mike Fraizer
We will continue to focus, Colin, in the U.S. and honing on where we have leadership and talking capital out of areas where we don’t. But beyond that, I think you shared your views and I appreciate those.
Colin Devine - Citi
I wish good luck to where the stock price is Mike.

Mike Fraizer
We will continue executing and try and sharpening where we allocate capital.

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