S&P Cuts Genworth Financial (GNW) to 'BB+'
Key Points:
- Genworth reported material reserve strengthening in its U.S. long-term care insurance business.
- Earnings volatility has increased and dividend capacity to the parent holding company is now more constricted.
- We are lowering our ratings on Genworth Financial Inc. and its U.S. life subsidiaries.
- The negative outlook reflects the need to rebuild capital strength, the risk of further reserve strengthening, and execution risk in the turnaround of the U.S. life insurance division.
Rating Action
On Nov. 6, 2014, Standard & Poor's Ratings Services lowered its long-term counterparty credit and senior unsecured debt ratings on Genworth Financial (NYSE: GNW) to 'BB+' from 'BBB-'. We also lowered our financial strength ratings on Genworth Life Insurance Co., Genworth Life and Annuity Insurance Co., and Genworth Life Insurance Co. of New York to 'BBB+' from 'A-'. The outlook is negative.
In addition to the rating actions on the core life subsidiaries, the following actions were also taken on various subsidiaries of Genworth:
- We lowered our financial strength ratings on Genworth Financial Mortgage Insurance Pty Ltd., the active Australian lenders' mortgage insurance (LMI) business, to 'A+' from 'AA-'. The outlook is negative. We affirmed our 'A-' rating on Australian LMI run-off subsidiary Genworth Financial Mortgage Indemnity Ltd. with a stable outlook.
- We lowered our financial strength rating on Genworth Financial Mortgage Insurance Co. Canada to 'A+' from 'AA-'. We also lowered the long-term counterparty credit rating on Genworth MI Canada Inc. (the holding company for the Canadian mortgage insurance business) to 'BBB+' from 'A-'. The outlook is negative.
- We lowered our ratings on U.K.-domiciled Genworth Financial Mortgage Insurance Ltd. to 'BB+' from 'BBB-' by virtue of a parent-company guarantee from Genworth Financial Inc. The outlook is negative.
- We placed our 'A-' ratings on Genworth's European protection business, Financial Assurance Co. Ltd. (FACL) and Financial Insurance Co. Ltd. (FICL) on CreditWatch negative.
Rationale
The downgrade of the core U.S. life insurance companies to 'BBB+' from 'A-' reflects our less-favorable assessment of the organization's inherent capital and earnings volatility and overall risk position after third-quarter earnings volatility. Genworth reported increased statutory disabled life reserving of $589 million in third-quarter 2014 driven by lower claims-termination rates and higher utilization rates than previously assumed in its U.S. long-term care business. The third-quarter charge represents more than 10% of the life companies' total adjusted capital (including Bermuda-based affiliate Brookfield Life and Annuity Insurance Co. Ltd. [BLAIC], which holds a significant portion of Genworth's long-term care liabilities). The heightened volatility increases our uncertainty about prospective claim and reserve development for this long-tail line of business. In addition, we believe that Genworth will face decreased consumer and regulatory receptivity to future
rate increases, as it manages the developing costs of its liabilities.
Despite reduced statutory capital of approximately $500 million in the third quarter, we believe the U.S. life insurance companies (including consolidation of BLAIC) remain adequately capitalized with a surplus redundancy for the 'BBB' rating level. We expect management to attempt to rebuild capital strength to a higher level through 2015, restricting any material dividends from the U.S. life companies to the parent at least for the next year. The U.S. life division's future profitability depends partly on ongoing rate increases for long-term care and renewed tractions in the overall turnaround strategy of the U.S. life division.
The downgrade of the parent holding company is attributable to the downgrade of the core life insurance companies. Because parent debt servicing relies on the dividend capacity from all primary subsidiaries globally, management's intent to limit U.S. life insurance company dividends to the parent and the U.S. mortgage insurance operations' inability to pay dividends until at least late 2015 (because they need capital to comply with new capital requirements) further constricts already less-than-adequate financial flexibility. In 2013, dividends from operating subsidiaries to the parent covered approximately 175% of debt-service needs. We expect dividends to cover approximately 50% of debt servicing needs in 2014, thus raising the probability of increased holding company cash utilization and asset sales.
Genworth's near-term earnings deterioration will lower consolidated cash fixed-charge coverage to about 1x-1.5x for full-year 2014, much less than the 3.5x generated in 2013. The parent had $1.1 billion in cash on its balance sheet as of Sept. 30, which provides a significant amount of financial flexibility in the near term.
The rating actions on the active Australian and Canadian mortgage insurance businesses are driven by the developments in the U.S. life insurance operations. The ratings on the insulated Australian and Canadian businesses are capped at three notches above the group credit profile under our group ratings methodology, and accordingly moved in step with the rating action on Genworth Life. The Australian and Canadian mortgage insurance businesses continue to have a very strong capital and earnings profile, in our view, though there is potential for further capital management initiatives in
addition to their targeted dividend payout ratio, and we see a greater demand from parent Genworth Financial for dividend payments. We expect the Canadian operating company to maintain regulatory capital of more than 220% of the minimum apital test (MCT) ratio. Ratings on Genworth Indemnity (the Australian LMI run-off subsidiary) are affirmed at its stand-alone credit profile level as an insulated subsidiary.
The placement of our ratings on FACL and FICL on CreditWatch with negative implications is pending our assessment of the independence of their financial strength from the Genworth group in light of increasing financial stress across the group, as well as the degree to which FACL/FICL's own creditworthiness could be affected. Under our group ratings methodology, the ratings on FACL/FICL cannot exceed those on the core U.S. life entities unless we view them as insulated. If this is the case, we expect to affirm the ratings with a negative outlook, reflecting that on the core U.S. life entities. If we do not view FACL/FICL as insulated, then we are likely to lower the ratings by one notch to the level of the ratings on the core U.S. life entities. The resolution of our CreditWatch, which we expect within the next 90 days, will depend on our assessment of the relative autonomy of FACL/FICL, particularly if the group financial profile deteriorates further.
Outlook
The negative outlook on the core life insurance companies, which indicates at least a one-third chance of a downgrade, reflects the need to rebuild capital strength, the risk of further reserve strengthening, and execution risk in the turnaround of the U.S. life insurance division. Moreover, the negative outlook captures our ongoing reassessment of management's operational effectiveness and ability to execute strategy, and the importance and effectiveness of Genworth's enterprise risk management program.
The negative outlook on the holding company reflects concerns in the core life insurance company outlook, loss of dividends from the life insurance division likely through late 2015, and execution risk at the U.S. mortgage division as it seeks to self-fund new government-sponsored entity capital requirements without calling upon parent cash. The outlook includes concern about low earnings capacity in the near term as well as low fixed-charge coverage.
Under our base-case assumptions capturing recent third-quarter developments, we expect Genworth Financial to generate consolidated break-even performance on a pretax basis for full-year 2014. This excludes any further reserve strengthening or material one-time charges for the remainder of 2014. We expect full-year 2014 consolidated financial leverage of 31%. We expect earnings improvement in 2015 that would restore capital strength at both the U.S. life and U.S. mortgage insurance divisions.
We could lower the ratings if the group financial profile further deteriorates. Any additional material reserve strengthening could result in a downgrade. Any perceived or actual inability to improve U.S. life division earnings would mute the benefit of diversification in our ratings and could result in a downgrade as well. We could also lower the ratings if we have a changed view of management's ability to execute its chosen strategy, or of Genworth's enterprise risk management program.
An upgrade at the U.S. life insurance companies is unlikely without a transformational improvement in operating fundamentals, including reduced earnings volatility during the next few years. An upgrade of the holding company is achievable but would depend highly on much improved earnings and dividend capacity across all major divisions of the enterprise, as well as restored strong capital strength at both the U.S. life and U.S. mortgage insurance divisions, and greatly improved fixed-charge coverage on a sustained basis.
Ratings Score Snapshot
To From
Group BRP/FRP Anchor BBB+ A-
Business Risk Profile Strong Strong
IICRA Low Risk Low Risk
Competitive Position Strong Strong
Financial Risk Profile Lower Adeq Upper Adeq
Capital and Earnings Moderate Strong Moderate Strong
Risk Position Moderate Intermediate
Financial Flexibility Less than Adeq Less than Adeq
Modifiers 0 0
ERM and Management 0 0
Enterprise Risk Management Adequate Adequate
Management and Governance Fair Fair
Holistic Analysis 0 0
Liquidity Strong Strong
Support 0 0
Group Support 0 0
Government Support 0 0
Ratings List
Downgraded; Outlook Action
To From
Genworth Financial Mortgage Insurance Pty Ltd.
Counterparty Credit Rating A+/Negative/-- AA-/Stable/--
Genworth Financial Mortgage Insurance Pty Ltd. (NZ Branch)
Genworth Financial Mortgage Insurance Pty Ltd.
Financial Strength Rating A+/Negative/-- AA-/Stable/--
Genworth Financial Mortgage Insurance Ltd.
Financial Strength Rating BB+/Negative/-- BBB-/Stable/--
Genworth Life Insurance Co. of New York
Counterparty Credit Rating BBB+/Negative/-- A-/Stable/--
Genworth Life Insurance Co. of New York
Genworth Life and Annuity Insurance Co.
Financial Strength Rating BBB+/Negative/-- A-/Stable/--
Genworth Holdings Inc.
Counterparty Credit Rating BB+/Negative/-- BBB-/Stable/--
Genworth Life Insurance Co.
Genworth Life and Annuity Insurance Co.
Counterparty Credit Rating BBB+/Negative/-- A-/Stable/--
Genworth Life Insurance Co.
Financial Strength Rating BBB+/Negative/-- A-/Stable/--
Downgraded; Outlook Action; Rating Affirmed
To From
Genworth Financial Inc.
Counterparty Credit Rating BB+/Negative/A-3 BBB-/Stable/A-3
Ratings Affirmed
Genworth Financial Mortgage Indemnity Ltd.
Counterparty Credit Rating A-/Stable/--
Financial Strength Rating A-/Stable/--
CreditWatch Action
To From
Financial Assurance Co. Ltd.
Financial Insurance Co. Ltd.
Counterparty Credit Rating A-/Watch Neg/-- A-/Stable/--
Financial Strength Rating A-/Watch Neg/-- A-/Stable/--
Downgraded
To From
Genworth Financial Mortgage Insurance Pty Ltd.
Subordinated A A+
Genworth Global Funding Trusts
Senior Secured BBB+ A-
Genworth Holdings Inc.
Senior Unsecured BB+ BBB-
Preferred Stock BB- BB
Insurance Note Capital RMI 2006-1
Senior Secured BB+ BBB-
Insurance Note Capital RMI 2006-2
Senior Secured BB+ BBB-
Insurance Note Capital RMI 2006-3
Senior Secured BB+ BBB-
River Lake Insurance Co.
Senior Secured BBB+ A-
River Lake Insurance Co. II
Senior Secured BBB+ A-