August 6, 2015
Genworth Analysis
Before making an investment decision, investors are advised toread carefully the Offering Memorandum, including thedescription of the risks, fees, expenses, liquidity restrictions andother terms of investing in the funds. Performance data has notbeen prepared to meet any specific requirements applicable to thepresentation thereof and should in no event be viewed aspredictions or representations as to actual future performance.Investment may involve a high degree of risk and should beconsidered only by investors who do not require access to theircapital and can withstand the loss of all or part of theirinvestment. Return targets in this document are subjectivedeterminations and do not reflect either actual past performanceor a guarantee of future performance. Referenced benchmarksmay fail to provide a meaningful comparison. Forward lookingstatements are based upon assumptions which may differmaterially from actual events. This information should not berelied upon in making an investment decision.
DISCLAIMER
Approach to investing:
Out-of-favor stocks that are mispriced due to uncertainty or fear, misunderstanding or obscurity
Conduct significant due diligence to overcome those hurdles
Invest only at a deep discount to intrinsic value
Limited to 15 to 20 best ideas
About Booth-Laird Investment Partnership
In-Depth Analysis
Genworth (ticker symbol: GNW) is a hybrid Mortgage Insurance, Life Insurance, and Long-Term Care (LTC) Insurance company
Spun-off from GE in 2004
Largest mortgage insurance company outside the U.S.
Pioneer in LTC insurance decades ago
$3.7B market cap
Profile
Unholy combination of P&C Insurance and Life Insurance
Issues in life insurance overshadowing strong p&c insurance
Beaten down to a low fraction of net book value
New management after severe issues from credit crisis
Plans to eventually split the p&c and life insurance businesses
Complexity that requires research, understanding, and patience
Described Hartford Group (HIG) 3 years ago and GNW today
HIG Redux 2012 revisited
Presented long thesis for Hartford Group (HIG) in July 2012
Stock was selling for 35% of NBV at ~$16/share
We felt it was trading for lower than a worst case scenario
Conservative upside was 60% of NBV in original analysis
Ultimately sold in July 2014 for $39 at 90% of NBV
143% gain in 2 years
How did HIG work out?
Selling for ~25% of net book value
Down 60% from 52-week high due to long-term care reserve issues
Probability of current management destroying 75% of net book value very low
Probability of net book value being overstated 400% very low
Risks misunderstood by the market due to complex accounting and new material weakness in controls
Substantial upside using three different valuation approaches
Asset Play Opportunity
Oldest predecessor founded 1871
GE Capital accumulated a number of disparate insurance companies
Spun off from GE in largest IPO of 2004
As a major U.S. and global mortgage insurer, severely hurt by the credit crisis
New management and majority of directors since crisis
Mortgage insurance past darkest hour, steadily improving
Late 2014, long-term care ins. reserve issues came to light
Review of reserves led to steep increase early 2015
Credit ratings reduced one notch as a result
Background
7 of 10 board members new since credit crisis, including Chairman
Rich insurance experience
Key executives replaced since credit crisis
CEO hired externally January 2013
CFO joined company in 2011
CRO hired externally January 2014
Greater focus on risk management
No accident LTC insurance issues came to surface in late 2014
Greater focus on simplicity no sacred cows
New Management
Unique combination of life, LTC, and mortgage insurance
Only major insurance company in all three businesses
Life insurance is not true insurance, it is an investment
Insurer cannot make money off of insurance premiums alone
Manage market risk only, not insurance risk
Mortgage insurance is true insurance
Pay a cost up front to protect against potentially larger cost later on
LTC is a combination of the two
Pay cost up to protect against potentially larger cost later on
Insurer cannot make money off of insurance premiums alone policies structured like life insurance
Complex Hybrid Model (1 of 2)
Included numerous other insurance lines as a result of GE kitchen sink spin-off
New management and board determine core of business was mortgage, life insurance, and LTC insurance
Sold or placed the remainder into run-off:
Variable annuities
Variable life insurance
Corporate-owned life insurance
Accidental & health insurance
Institutional insurance
Medicare supplement insurance
International Protection insurance
Complex Hybrid Model (2 of 2)
Now a strength of the company
#1 private mortgage insurer in Australia and in Canada
Both markets essentially oligopolies
A leading private mortgage insurer in the U.S.
Post-European recession, only offers mortgage insurance in 4 countries Germany, UK, Finland, and Italy
97% of mortgage insurance sold to prime borrowers
Mortgage Insurance Profile
Publicly-traded in Australia IPO in 2014
Trading for 0.88x net book value
GNW still owns 51% of the company
4 banks handle vast majority of mortgages in Australia
Estimated 44% market share
Lost one major bank customer 2015 over ratings reduction stemming from LTC insurance 10-15% of policies
No impact on policies in force, no material impact on net income
Loss ratios are outperforming local market
Well capitalized capital adequacy ratio exceeds target
Australia Mortgage Insurance (AMI)
AMI Combined Ratio
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
100.00%
2012 2013 2014 2015E
Loss Ratio Combined Ratio
AMI TTM Underlying ROE
10.4%
11.7%12.0% 11.9%
12.2%12.4%
4Q13 1Q14 2Q14 3Q14 4Q14 1Q15
12 month trailing underlying ROE
Publicly-traded in Canada IPO in 2009
Trading for 0.81x net book value
GNW still owns 57.5% of the company
Largest private insurer in Canada
Mort. Ins. 90% guaranteed by Canadian government
Book Value per Share has increased at a CAGR of 9.3% last 5 years
Average operating ROE of 12.8% last 6 years
Well capitalized capital adequacy ratio exceeds target
Low interest rate for foreseeable future
Canada Mortgage Insurance (CMI)
CMI Combined Ratio
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
100.00%
2012 2013 2014 2015E
Loss Ratio Combined Ratio
CMI Operating ROE
14.0%13.0% 13.0%
12.0% 12.0%
2010 2011 2012 2013 2014
Wholly-owned
7 Mortgage Insurance companies before credit crisis
2 went bankrupt
2 more nearly went bankrupt
GNW did not come close
Claims skyrocketed due to crisis
Delinquencies peaked in 2010
Down substantially and still dropping
61% of risk in force composed of 2009+ loans
Returned to profitability in 2013
ROE of 5.6% 2014 is low but improving
U.S. Mortgage Insurance (USMI)
USMI Combined Ratio Improving
40.00%
60.00%
80.00%
100.00%
120.00%
140.00%
160.00%
180.00%
2012 2013 2014 2015E
Combined Ratio Breakdown
Loss Ratio Combined Ratio
USMI Op Income Improving
$(114)
$37
$91 $101
$(150)
$(100)
$(50)
$-
$50
$100
$150
2012 2013 2014 1H 2015
Government Sponsored Entities (GSEs)
Want a vibrant private mortgage insurance industry
Suspended rules requirements during crisis
Announced new capital adequacy rules effective mid-2015
GNW expects to meet new rules
Needs to increase capital $500-$700M
Sold additional Australia stock
Sold international protection business
Utilizing captive reinsurance
In compliance with maximum leverage ratio of 25:1
GNW at 13.7:1 and dropping
USMI Capitalization
Includes life, annuities, and LTC insurance
Universal Life and Fixed Annuities are primary focus going forward for non-LTC business
Well capitalized RBC ratio of 455% exceeds target of 400% and regulator requirements of even lower percentages
For reference, respected stalwart New York Lifes RBC ratio is 500%
Non-LTC products are steady performers
TTM ROE of ~4% is low but improving
Will benefit substantially from a rising interest rate environment
Reducing headcount and other expenses to further improve ROE
Life Insurance Business
Insurance ratings reduced by Moodys, S&P, and A.M. Best as a result of LTC reserve increase still adequate and above
Reduction in insurance rating caused some brokers to stop selling new GNW products
Represents 18% of linked-benefit, 16% of annuity, and 9% of LTC sales
No impact on existing policies vast majority of annual premium
Could be bumped back to previous ratings as LTC uncertainty recedes
Life Insurance Ratings Reduction
DALBAR announced insurance awards 2014
Received 2014 Service Award for life insurance unit
Ranked first for high quality of service in LTC
Ranked 3rd for quality of service provided to life insurance policyholders
Received Annuity Service Award
1 of 6 six companies that emerged as titans of customer service in 2014
Per DALBAR:
Genworth emerged as an industry leader for 4th consecutive year, with proven leadership in the high level of professionalism, knowledge and respect for the their policyholders that was found in over 94% of calls evaluated for service.
Industry average is only 57%
Respected Operator
Source of why stock is down
LTC Insurance primer:
Covers cost of the elderly and disabled who can no longer care for themselves but do not warrant stay in the hospital
Average age of first year policyholder is 58
Average age of first year of claim is 80
Average duration of claims is 3 years
Like life insurance, claims exceed premiums paid over life of policy, so company relies on policy lapses and sufficient investment yield
GNW was a pioneer of LTC insurance 30 to 40 years ago
Few competitors today
LTC Insurance
Lack of historical data and unexpected advances in medicine caused the following key assumptions to be underestimated when policy first written decades ago
Lapse rate
Used avg. life insurance lapse rate of 5 to 6%, but actual lapse rate has been 0.7%
Frequency - % of policyholders making claims
Severity total cost once claim is made
Result
Significant increase in reserves for future claims
LTC Insurance Issues
LTC reserves typically reviewed once every 4 years
Last review in 2012 accredited incorrect assumptions to credit crisis, made no major adjustments
New management came on board after, notice the key variables were still off, ordered a complete review in 2014, 2 years ahead of schedule
With Q3 2014 earnings release, announced increase in claims reserve and review of the Active Life Reserve, to be released with Q4 2014
Hired two actuarial firms, one to calculate the new reserve and the other to review the calculation
Vetted the new reserve calculations with regulators
LTC Insurance Reserve Review
2 separate reserves:
Claims reserve for current claims - policyholders receiving benefits today. Severity key variable Increased $700M, new survival ratio of 4.6 is
conservative
Active Life Reserves policyholders who have yet to make a claim Increased another $700M for older acquired block
expected to realize a loss Reduced expected profit on organic block, but no
reduction in NBV needed unless expect a loss Extensive vetting process and assumptions used provide
comfort
Also wrote off $500M of goodwill
LTC Insurance Reserve Update
Increasing rates on existing policies and reducing benefits
Working with state insurance commissioners
Requesting increases of 15-40%
Rate increases are product by product
Received approval from 47 states for one product
Received approval from 30 states from another product
Exited 2 states where rate increases not approved
Adverse selection will occur used conservative lapse rate for reserves as a result
LTC Insurance Rate Increases
Company expects the requested rate increases to result in increased premiums for existing policies of $380 470M by 2017 with no additional cost
Net operating income, after tax, for LTC the last 3 years:
2012 - $101M
2013 - $129M
2014 - $59M before the reserve increase
Benefit reductions also reduce reserve requirements
Expect to increase rates annually for existing policies to get to appropriate profitability level
Expect ROE of 20% on new policies written going forward
LTC Insurance Going Forward
Management has openly discussed its intent to eventually split up the mortgage and life insurance businesses, most likely via a spin-off of one of the units
Would unlock the value in the mortgage insurance businesses evidenced by the Australia and Canada subs
Overshadowed by LTC issues
Combination of two very different businesses keeps a lot of investors away
Split would create purer plays and likely increase investor interest for both businesses
Plans delayed temporarily by LTC and by new USMI capital requirements
Likely no sooner than FY 2016 probably later
Likely Split in the Future
Material Weakness disclosed with 2014 10-K
Related to immaterial error that was not caught in an Excel spreadsheet
Determined it could have been material
Wall Streets reaction to and commentary on the material weakness reveals a lack of understanding of what that actually means and the impact
Our audit background, particularly of Shaw and its numerous material weaknesses, provides a deep understanding
Risk is the material weakness that you dont know about, not the one you do know about and overcome with extensive managerial and auditor review
Material Weakness
1. Reserves could prove to be inadequate
2. Regulatory risk in all markets is ever present when dealing with financial companies
3. Company may not be able to get any additional rate increases on LTC Insurance
4. Any further insurance rating reductions would hurt the stock
Risks to Consider
Valued using three methods
1. Projecting net income by business line and summing the parts
2. Balance sheet approach primary focus since asset play
3. Based on statutory capital sanity check
Completed upside and downside valuation
Upside conservative
Downside aggressive to incorporate worst case scenarios
Valuation Methodology
Primarily viewed as an Asset Play, similar to HIG
Limited to financial companies assets and liabilities predominantly financial in nature
Why we love asset plays:
Rare
Reduces execution risk
The farther below realizable net asset value, the less the execution risk
We pass on most due to inability to determine a reasonable maximum liability
Asset Play
Primarily focused on stressing balance sheet to determine maximum realistic destruction of value
Eliminated unrealized gain in fixed maturities portfolio in OCI, even for upside
Assumed further increase in LTC reserves of over $3B
Increasing acquired block loss and eliminating organic block margin plus an additional hit of $2.6B for assumption changes
Key is to ensure our risk of losing money is very low
Proof of conservative approach
Assumed $0 for lifestyle protection business or write-off of full NBV of $815 in original analysis when invested even for our upside analysis
Company recently announced sale for $510M
Key Assumptions
Valuation
Weighted Avg Valuation Upside Downside
Intrinsic Value $16 $8.85
Stock Price $5.64 $5.64
Upside 183% 57%
Focus is on the balance sheet, not earnings Key is determining if more than 75% of NBV will be
destroyed or written off since currently selling for 25% of NBV Even when stressing it aggressively, at worst the
company is worth 40% of Q2 2015 NBV
1. Primarily beating lowered expectations
2. An increase in insurance ratings
3. Time to prove new LTC reserve levels are adequate or capping the risk in some way
4. Continuing to get rate increases approved by the majority of states for LTC insurance
5. Announcing they can begin paying a dividend again from USMI to the holding company
6. Successfully splitting the company into separate mortgage and life insurance businesses
Catalysts
Stock dropped 20% in one day - ridiculous overreaction
Results showed continued progress and stability of NBV (highest priority for us)
Market wanted a big announcement on sale of life and annuity business
Mgmt decided not to sell life and annuity because the offers were too low and it could impact their ratings
We applaud this decision
Life, annuity, and LTC should be a package deal if LTC is to be readily accepted still intend to split business eventually
HIG made a mistake by announcing intention to sell life and annuity before finding buyer in 2012, which significantly hurt distribution
Have to show a commitment for brokers to promote it
Market reaction to Q2 15 results
Appendix
Passed CPA exam, ABV exam, and all 3 CFA exams on first attempt
2006 Elijah Watt Sells Award (top 10 CPA exam score in the world out of 50,000+ test takers)
2008 Baton Rouge Business Report Top 40 Under Forty Award
B.S., Accounting and M.S., Accounting from Louisiana State University
3+ years of auditing experience with two of the Big 4 accounting firms
Exceptional performer every year & early promoted
Lead senior of Fortune 500 audit client
Former Assistant Director of State Economic Competitiveness under Governor Jindal
Accredited Member magazine and SeekingAlpha.com contributing author
About the Managers:Jonathan Booth, CFA, CPA/ABV
7 years of accounting and auditing experience with
KPMG Big 4 accounting firm
Postlethwaite & Netterville largest accounting firm in Louisiana
The Edgen Group Manager of Financial Reporting
Edgen-Murray Corporation Assistant Controller
B.S., Accounting from Louisiana State University
M.B.A. from Southeastern Louisiana University
Louisiana Society of CPAs Business & Industry Committee
2012 AICPA Leadership Academy one of 36 selected from across the nation for prestigious 4 day event
About the Managers:Kevin Laird, CPA
Contact Information
Booth-Laird Investment Partnership
9005 Westlake Avenue
Baton Rouge, LA 70810
(225) 767-1439
Jonathan Booth, CFA, CPA/ABV
Chief Executive Officer
Cell: (225) 978-1532
Website: www.boothlaird.com
Blog: www.boothlaird.com/boothlairdblog/
Twitter: http://twitter.com/#!/BoothLaird
Kevin Laird, CPA
President & Chief Operating Officer
Cell: (225) 229-6567