Overview
-- Earnings have not met our expectations for the rating level andfinancial flexibility continues to be strained.
-- We are lowering our ratings on Genworth Financial Inc., Genworth LifeInsurance Co., and core U.S. life operations.
-- The negative outlook on the holding company hinges primarily on theexecution of the strategic review conducted by management and the board.
-- The outlook on the U.S. life operations is stable.
Rating ActionOn Oct. 11, 2012, Standard & Poor's Ratings Services lowered its counterpartycredit rating on Genworth Financial Inc. (GNW) to 'BBB-/A-3' from 'BBB/A-2'.At the same time we lowered the insurer financial strength rating andcounterparty credit rating on Genworth Life Insurance Co. (GLIC) and core U.S.life operations to 'A-/A-2' from 'A/A-1'. We also downgraded GenworthFinancial Mortgage Insurance Ltd. to 'BBB-' because it relies on aholding-company guarantee.
Rationale
We continue to view GNW as investment grade due to its increased liquidity atthe holding company, significant improvement in its U.S. mortgage insuranceplatform year to date, the Australian mortgage insurer's return toprofitability in the second quarter, and the positive momentum in unassignedsurplus at the U.S. life operations. However, we are lowering the counterpartycredit rating by one notch to reflect the low earnings level for theorganization (below expectations for the 'BBB' category) and the difficulty itwill face expanding margins globally in the weak economy.
GNW let its two five-year credit facilities expire this year, and although wedon't think a full renewal was necessary given a shift in its mix ofbusinesses, the move highlights a straining of its financial flexibility inthe capital markets. Finally, GNW's indenture contains a clause (section6.01(g)) whereby the outstanding principal would become due and payableimmediately if a "significant subsidiary" is adjudicated bankrupt orinsolvent, or placed under court-ordered regulatory receivership. GenworthMortgage Insurance Corp. is considered a "significant subsidiary." Although wethink the likelihood of this clause being triggered is remote, we believe thatit hampers GNW's financial flexibility in the marketplace and increases itsfinancing costs above peer companies'.
The U.S. life operations are being downgraded one notch because of thebusiness's sensitivity to interest rates (fixed annuities and long-term care
), and its underperforming legacy term and LTC blocks that will take timeto stabilize and improve. In addition, financial flexibility continues to beaffected by the ongoing stress at the holding company and the expectation forthe life operations to support holding company interest expenses. Thecompany's two main competitive advantages are in the commoditized term productand interest sensitive LTC. Legacy blocks that impede margin expansioncontinue to hurt both product lines. While management improves its position(as exemplified by its life block transaction completed in first-quarter 2012
), its ability to significantly and quickly alter the in-forcebook is limited. The margin compression on the remaining legacy term block dueto failed auctions in its RiverLake structures is a hindrance. Whileregulatory approvals of announced premium rate increases on the legacy LTCblock are expected starting in 2013, it will take a few years for theseincreases to be fully recognized in premium revenue. Lapsation, morbidity,termination rates, and interest rates have all led to the deterioration of theblock, necessitating the large premium increases that GNW recently announced.
The 'A-' U.S. life operations are supported by a strong business profile withleadership positions in both term life and LTC product lines. The streamliningof its product set following the sale of the Medicare supplement business andexit of the variable annuity line has allowed GLIC to better focus on its corecompetencies. Strong and improving capitalization at the U.S. life companyalso supports the 'A-' rating. We expect the U.S. life operations to become aregular dividend-paying entity to the parent company.
Finally, we believe that management has successfully hedged a significant partof its interest rate risk on its LTC block primarily through forward-startingswaps. As of second-quarter 2012, it has more than $2 billion in cash-flowhedge gains in accumulated other comprehensive income. Assuming interest ratesstay level, these gains will be amortized into earnings over time.
Outlook
The outlook on GNW is negative, reflecting the low fixed-charge coveragemetrics, the uneven business performance, and the continued poor, albeitimproved, performance at the U.S. mortgage insurer. Financing costs are morethan peer companies' and likely factored into management's decision not torenew the credit facilities. We believe that the ongoing strategic review willaddress many of the factors that currently strain the company's financialflexibility. However, until management can execute its plans, we believe thereare still downward rating scenarios given the volatility in operatingperformance since the start of the financial crisis. We would expect to reviewthe outlook within six to 12 months as the strategic plans are executed andoperating earnings trend above or below the 3x-5x coverage level expected forthe ratings. In addition, we believe that to maintain the investment-graderating, management needs to continue to hold a buffer in excess of 2x holdingcompany interest expense.
The outlook on the life companies is stable, reflecting their strong capitaland business positions. We are unlikely to change the ratings during the next18-24 months. However, we could lower the ratings if the holding companyrelies too heavily on the U.S. life operations to service its debt, hinderingcapital formation and leading to sustained capital levels below the 'A' level.We could also lower the rating if the legacy LTC business further deterioratesand management actions are insufficient to stabilize the block. We could raisethe ratings if the life companies can more quickly improve underperformingbusiness lines and improve operating fundamentals in line with other companiesthat are rated 'A'.
Related Criteria And ResearchHolding Company Analysis, June 11, 2009Ratings ListDowngradedTo FromGenworth Financial Inc.Counterparty Credit RatingLocal Currency BBB-/Negative/A-3 BBB/Negative/A-2
Genworth Financial Mortgage Insurance Ltd.
Counterparty Credit RatingLocal Currency BBB-/Negative/-- BBB/Negative/--Financial Strength RatingLocal Currency BBB-/Negative/-- BBB/Negative/--Genworth Life Insurance Co.Genworth Life and Annuity Insurance Co.Counterparty Credit RatingLocal Currency A-/Stable/A-2 A/Stable/A-1Genworth Life Insurance Co.Financial Strength RatingLocal Currency A-/Stable/A-2 A/Stable/A-1
Genworth Life Insurance Co. of New York
Counterparty Credit RatingLocal Currency A-/Stable/-- A/Stable/--Genworth Life Insurance Co. of New YorkGenworth Life and Annuity Insurance Co.Financial Strength RatingLocal Currency A-/Stable/-- A/Stable/--Genworth Financial Inc.Senior Unsecured BBB- BBBPreferred Stock BB BB+Commercial Paper A-3 A-2
Genworth Global Funding Trusts
Senior Secured A- A
Genworth Life Institutional Funding Trust
Senior Secured A- A
Insurance Note Capital RMI 2006-1
Senior Secured BBB- BBB
Insurance Note Capital RMI 2006-2
Senior Secured BBB- BBB
Insurance Note Capital RMI 2006-3
Senior Secured BBB- BBBRiver Lake Insurance Co.Senior Secured A- ASenior Unsecured A- ARiver Lake Insurance Co. IISenior Secured A- ASenior Unsecured A- A
River Lake Insurance Co. IV Ltd.
Senior Secured A- ASubordinated BB+ BBB-
Complete ratings information is available to subscribers of RatingsDirect onthe Global Credit Portal at
. All ratings affectedby this rating action can be found on Standard & Poor's public Web site at. Use the Ratings search box located in the leftcolumn.(New York Ratings Team)
((e-mail: pam.niimi@thomsonreuters.com; Reuters Messaging:pam.niimi.reuters.com@reuters.net; Tel:1-646-223-6330;))