S&P Cuts Genworth Financial (GNW), U.S. Subsidiaries Two Notches to 'BBB-'

Standard & Poor's Ratings Services said today that it lowered its counterparty credit and financial strength ratings on Genworth Financial Inc.'s (NYSE: GNW) U.S. life insurance subsidiaries--Genworth Life Insurance Co., Genworth Life & Annuity Insurance Co., and Genworth Life Insurance Co. of New York--to 'BBB-' from 'BBB+'. At the same time, Standard & Poor's lowered its counterparty credit ratings on Genworth Financial Inc. and Genworth Holdings Inc. to 'BB-' from 'BB+'. The outlook on all of these companies is negative.

In addition, Standard & Poor's took the following actions on Genworth's various other subsidiaries:

• We affirmed our 'A+' counterparty credit and financial strength ratings on Genworth Financial Mortgage Insurance Co. Canada and our 'BBB+' counterparty credit rating on Canadian holding company Genworth MI Canada Inc. We revised the outlook on these companies to stable from negative.
• We affirmed our 'A+' counterparty credit and financial strength ratings on Genworth Financial Mortgage Insurance Pty Ltd. and Genworth Financial Mortgage Insurance Pty Ltd. (NZ Branch), (Genworth Australia), the active Australian lenders' mortgage insurance (LMI) business. We also affirmed our 'A-' rating on Australian LMI run-off subsidiary Genworth Financial Mortgage Indemnity Ltd. We revised our outlook on Genworth Australia to developing from negative, and we revised our outlook on Genworth Financial Mortgage Indemnity Ltd. to developing from stable.
• We lowered the ratings on U.K.-domiciled Genworth Financial Mortgage Insurance Ltd. to 'BB-' because of the guarantee from parent company Genworth Financial Inc.
• The ratings on Genworth's U.S. mortgage insurance entities--Genworth Mortgage Insurance Corp. and Genworth Mortgage Insurance Corp. of North Carolina (GMICO)--are unchanged at 'BB-', and the outlook is positive.
• The 'A-' ratings on Genworth's U.K.-based insurers, Financial Insurance Co. Ltd. And Financial Assurance Co. Ltd., are unchanged and remain on CreditWatch with negative implications.

The two-notch downgrade of the core U.S. life insurance companies partly reflects our view that Genworth's operating performance is--and future profitability will be--weaker than we had assumed. Genworth reported a fourth-quarter 2014 net loss of $760 million. This follows a third-quarter 2014 net loss of $844 million, resulting in a full-year 2014 net loss of $1.2 billion. The organization's global mortgage insurance business continues to perform well, as demonstrated by its net operating income of $436 million in 2014, which is an improvement from $398 million in the prior year. However, the consolidated full-year net loss stemmed from the company's U.S. life division, particularly its long-term care insurance business. In the fourth quarter, Genworth reduced its long-term care active life margin by almost 50% due to higher claims expectations and impaired all remaining goodwill.

The future profitability of the company's long-term care business--and, consequently, its U.S. life division--depends increasingly on continued regulatory approval for and policyholder acceptance of rate increases and benefit reduction options. Although Genworth's long-term care business is partially hedged against low interest rates, it remains susceptible to prospective reserve strengthening due to the sensitivity of its actuarial assumptions and the increasing average age of its policyholders.

In addition, we have taken into account Genworth's continued one-time accounting adjustments and corrections in the U.S. life division. The group reported $48 million in fourth-quarter accounting adjustments after similar adjustments in the third quarter. These adjustments raise questions about the strength of operational controls. Management's need to remedy operational controls and reverse the trajectory of the U.S. life division in a timely manner emphasizes the high importance of both strategic execution and enterprise risk management at this time.

Although the U.S. life companies' unassigned surplus declined by $285 million in 2014, we view current U.S. life insurance capital as redundant at the 'BBB' rating category level. We anticipate a decrease in capital strength this year (though we believe it will remain redundant at the 'BBB' rating category level), due largely to the dilutive impact of its planned repatriation of its Bermuda captive. We believe Genworth's capital strength will rebound in 2016 and 2017 through retained earnings and no dividend payments to the parent holding company. We view current capital strength at Genworth Mortgage Insurance Co. (GMICO) as improving but still somewhat less than adequate.

The downgrade of the parent holding company is largely attributable to the downgrade of the core life insurance companies. Although the parent holding company had more than $1 billion in cash and securities on its balance sheet at year-end 2014, it is highly reliant upon the divided capacity of its subsidiaries to fund its debt-servicing requirements of approximately $280 million annually and the repayment of Genworth's next debt maturity of $300 million in December 2016. The U.S. mortgage insurance unit is unlikely to pay dividends until at least 2016 as it rebuilds its own capital strength. Management has also indicated a likely extension of its self-imposed dividend stoppage from the U.S. life insurance companies to the parent. Thus, the constraint on the parent's financial flexibility will likely persist, as it will have to rely on its Australian and Canadian units for dividends in 2015 and 2016. Dividends from operating subsidiaries to the parent covered
approximately 175% of debt-service needs in 2013, though this figure declined to about 50% in 2014.

We affirmed our ratings on Genworth's Canadian mortgage insurance entities, Genworth Financial Mortgage Insurance Co of Canada and Genworth MI Canada Inc. We revised the outlook on these companies to stable from negative. These actions reflect our updated stand-alone assessment that the current ratings sufficiently capture any adverse brand, reputational, or financial influence related to credit quality deterioration at Genworth's U.S. operations.

We have affirmed our 'A+' ratings on Genworth Financial Mortgage Insurance Pty Ltd. and its New Zealand branch. The outlook has been revised to developing from negative. The affirmation reflects our updated stand-alone assessment, which incorporates our view that the current ratings sufficiently capture any adverse brand, reputational, or financial influence related to developments at Genworth's U.S. operations. The revised outlook reflects management's public statements about evaluating its strategic options with regards to its operations in Australia.

We view both the Australian and Canadian entities as relatively insulated from the credit deterioration in the U.S. operations, given local regulatory oversight, external minority ownership, and restrictions on capital fungibility. However, we have not de-linked the ratings on Genworth's ongoing Australian and Canadian entities from the ratings on the core Genworth life companies. Rather, we have allowed greater notching due to our updated assessment about insulation. We reasonably expect local regulators to act to prevent the subsidiaries from supporting the group to an extent that would impair the subsidiaries' stand-alone creditworthiness. We believe that our current ratings capture the likely minimum capital requirements to be enforced, if necessary, in both Australia and Canada.

The ratings on Genworth Mortgage Insurance Corp. and Genworth Mortgage Insurance Corp. of North Carolina remain unchanged at 'BB-', and the outlook is positive.

The negative outlook on the U.S. life insurance companies, which indicates a one-in-three likelihood of a downgrade over the next 24 months, reflects execution risk given the significant challenges management will encounter in implementing a successful turnaround strategy. Moreover, the outlook captures our ongoing reassessment of management and governance as the company develops and executes strategic options and the effectiveness of Genworth's enterprise risk management program.

The negative outlook on the holding company reflects the issues related to the core life companies, increased reliance on asset sales, and low fixed-charge coverage.

We could lower the ratings on the core U.S. life companies and U.S. holding companies again if the group financial profile further deteriorates or if our ongoing assessments of management, governance, and enterprise risk management were to weaken. An upgrade of the core U.S. life companies rating is unlikely without a transformational improvement in operating performance.

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