Genworth Financial Inc (GNW) 2008 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Genworth Financial's second-quarter earnings conference call. My name is Stacey and I'll be your coordinator today. At this time all participants are in listen-only mode. We will facilitate a question-and-answer session towards the end of this conference call. As a reminder, the conference is being recorded for replay purposes. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to Alicia Charity, Vice President Investor Relations. Ms. Charity, you may proceed.

Thank you, operator, and welcome to Genworth Financial's second-quarter 2008 earnings conference call. Our press release with expanded tables and an abbreviated supplement were both released last night and are posted on our website. Finalizing the evaluations on investment securities delayed production of the financial supplement in its entirety; it will be filed in an 8-K and posted on our website on Friday.

This morning you'll hear from Mike Frazier, our Chairman and CEO, and then Pat Kelleher, our Chief Financial Officer. Following our prepared comments we'll open up the call for a question-and-answer period. Pam Schutz, Executive Vice President of our Retirement & Protection Segment; Tom Mann, Executive Vice President of our International Segment; and Kevin Schneider, President of US Mortgage Insurance, as well as other business leaders will be available to take questions.

With regard to forward-looking statements and the use of non-GAAP financial information, some of the statements we make during the call today may contain forward-looking statements. Our actual results may differ materially from such statements. We advise you to read the cautionary note regarding forward-looking statements in our earnings release and the risk factors section of our most recent annual report Form 10-K filed with the SEC in February 2008.

Today's discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. In our abbreviated supplement and earnings release non-GAAP measures have been reconciled to GAAP where required in accordance with SEC rules. And finally, when we talk about international segment results, please note that all percent changes exclude the impact of foreign exchange. And with that let me turn the call over to Mike Fraizer.

Thanks, Alicia. Genworth weathered a difficult environment in the first half and we anticipate and are prepared for a similar environment through the rest of the year and into 2009. Clearly we are not satisfied with our overall current performance levels.

While we see strength in our international operations we have several business lines, along with their investment portfolios, feeling some strain from the spreading impacts of market downturns. We are aggressively managing through this landscape on multiple fronts. Our focus is simple -- take necessary actions today to position the business for the future and improve 2009 performance.

We believe the strong steps we are taking now will accomplish this goal. We are mindful that the environment is still evolving, but our visibility today into our US Mortgage Insurance and investment portfolios is clearer than it has been since the housing market crisis and subsequent general financial turmoil began. And this visibility has led us to make some additional shifts to asset portfolios and loss mitigation activities in the US and globally.

With that, we continue to take decisive actions to deal with Mortgage Insurance related risks at Genworth. We are positioning the US Mortgage Insurance business model for improved future profitability. For example, we moved first in the industry to increase core pricing levels, a trend now effective across most of the market. We continue to restrict underwriting criteria in declining geographic submarkets and we are realizing material benefits from loss mitigation activities which are important steps that will make this business stronger along with the recent passage of housing legislation.

We're also taking action to have the flexibility to reposition our investment portfolio to support Genworth's risk tolerance and related strategies. This change of intent to hold certain securities resulted in the $215 million out of the total of $359 million after-tax impairments that you saw in the quarter and the accompanying $40 million negative tax impact on operating earnings. I would note that the realized loss associated with change of intent does not flow through this statutory income.

Again, this action gives us flexibility to be opportunistic and move into the markets at a time of our choosing to reposition securities that we believe have no value recovery opportunity or no longer fit with our portfolio.

Finally, we are focused on maintaining capital flexibility and sound capital positions without the need to raise additional equity capital as we move through this period. We are closely managing our risk-based capital and risk to capital ratios. We use various approaches, including traditional reinsurance to free [trap] capital, repositioning of assets to increase capital availability or by accessing external capital through reinsurance structures that would fund targeted new business growth in a more efficient and profitable manner.

The bottom line is that we take preserving shareholder capital and maintaining capital flexibility very seriously and this remains top of mind for myself and the management team.

With the first half completed and after taking a hard look at the environment we are affirming our 2008 outlook for net operating earnings per share in the $2.25 to $2.65 range. We expect the tax rate to decline in the second half of 2008 and to recoup the $40 million in higher taxes in this quarter with a full year effective tax rate of around 27%. I would expect to provide some directional outlook for 2009 on our next earnings call toward the end of October and present a more comprehensive view at a December investor update.

This morning Pat and I will focus on four key areas where we are actively working to manage risk and position Genworth for the future. First, on US Mortgage Insurance where we are making good progress in navigating today's market while shifting the business to a more profitable model. Second, on how we are carefully growing our international business and delivering strong earnings growth. Then Pat will walk through our investment portfolio performance and, finally, he will provide some additional detail on how we are driving capital flexibility.

Let me start with US Mortgage Insurance. As we have seen for the past several quarters, incurred bosses in US Mortgage Insurance are more pronounced in those states that previously experienced the most rapid home price appreciation levels and use of alternative products. These include Florida, California, Arizona and Nevada, which combined accounted for more than 80% of the increase in reserves this quarter. These four states, plus Michigan and Ohio where the economies have been sluggish, give us six states we consider at key geographic risk exposures.

Lender captive reinsurance absorbed $110 million or about 29% of total flow losses in the quarter with those benefits going mainly to the 2006 and 2007 vintages. We anticipate lender captive reinsurance will provide protection benefits to the 2005 vintage later this year and into subsequent years. We have also intensified loss mitigation efforts, nearly tripling the number of specialists focused on these activities. We worked out nearly 3,000 loans in the quarter, enabling many families to stay in their homes.

In addition, while Genworth pays all legitimate claims, we have increased investigations in line with the core underwriting practices we have seen in portions of the 2006 and 2007 books in particular. We have taken strong actions to improve the quality and profitability of the 2008 and future books excluding many products, limiting loan to value ratios and raising price by more than 20%, as we announced in April.

The business we are writing today has a maximum loan to value of 90% in a total of 144 markets we identified as having increased potential for home price declines with selective exceptions for affordable housing programs. These restricted markets would represent about half of the source of anticipated new business originations. Moreover the vast majority of these loans are GSE conforming with a minimum FICO score of 680 and no alternative products.

As a result of our guideline changes, product exits and price increases the 2008 book has characteristics to withstand a significantly higher claims rate than we expect and still produce attractive profitability. Finally, we are very pleased with the passage of the Housing Bill and public policy and regulatory steps being taken to help the housing market regain stability while promoting sound underwriting disciplines.

Now let me turn to our international segment. Here results in the quarter were strong, up 15% excluding foreign exchange. Payment protection performed well, driven by its strong position on the European continent with earnings up 26% while still investing prudently in new markets. International Mortgage Insurance also performed well, up 12%, driven by our Australian and Canadian platforms.

I would note that many of the conditions that are driving difficulties in the US housing market are not characteristic of global housing markets and, in particular, Canada and Australia which together represent about 95% of international Mortgage Insurance risk in force. High-risk lending such as nonprime, NoDoc and 100% loan to value lending are far less common in these geographies. In addition, capital markets funding of high-risk products was not a factor in these markets.

Our sound loss performance in Canada and Australia demonstrates that these markets are structured differently and will continue to perform better than the US. Our loss ratio in Australia has been trending down over the past several quarters and in Canada losses improved sequentially and remain well below pricing. This quarter we have added disclosure in our supplement so you can see the attractiveness of international Mortgage Insurance in these two leading platforms and examine performance characteristics at a more granular level.

That being said, we do recognize the global economies are gradually slowing. In Australia and Canada home price appreciation is expected to slow from double-digit levels in 2007 to the 4% to 5% range in 2008, and GDP in these markets is expected to decline somewhat as well. The economic and housing slowdowns in several European countries are more pronounced. For Genworth this represents only 5% of international risk in force and much of it has significant levels of embedded home price appreciation behind it.

Genworth is taking broad actions to manage risk and position our international segment for continued strong performance in this gradually slowing environment. In Canada we have tightened underwriting and implemented product changes where appropriate and will continue to do so. Concurrent with these moves the government recently announced certain shifts in loan products it will guarantee through its backstop program including eliminating loans with loan to values over 95% and 40-year amortizations.

The government is also requiring guaranteed portfolios to have less than 3% of exposures to loans with credit scores of less than 620. Genworth has already met or will meet these moves and currently satisfies the last test related to FICO score exposure.

In Australia we are maintaining a path started in 2006 to tighten underwriting where we anticipate higher future risk factors. This is demonstrated by tightening underwriting in certain areas of New South Wales and restricting loan-to-value levels in Western Australia where home price appreciation has been growing more quickly. In addition, and as a result of the slowdown in mortgage finance, the majority of our new insurance written has shifted to large deposit taking lenders that traditionally have very strong underwriting routines.

In Europe our book is generally well seasoned. We have limited production in the UK and the book is small and very seasoned with an effective loan to value of 68%. In Spain we saw weak performance in certain portions of our book and aggressively tightened new business underwriting, repriced product and exited several relationships. As a result, new insurance written in Spain is down over 90%. We do expect some volatility in the loss ratio in Spain in future quarters and are focused on loss mitigation including working with lenders to limit future risk.

To wrap up, Genworth is intently managing through a challenging market environment, actively taking steps to manage risks, ensure sound capital positions and flexibility, prudently invest in growth and position Genworth for the future including improved 2009 performance. With that I'll turn the call over to Pat. Pat?

Thank you. As Mike said, I will focus on two areas this morning -- the investment portfolio and our capital position. Composition of our investment portfolio has shifted modestly during the quarter and we are proactively and decisively managing this shift to mitigate risk and to optimize returns in the current financial market environment.

Specifically we have been trimming corporate bond holdings in certain financial services and consumer demand-driven sectors, increasing cash holdings for normal operating needs but also for redeployment opportunities in sectors that we feel are more attractive, and taking a more segmented approach to the RMBS portfolio. These actions are important steps to enable repositioning of the investment portfolio going forward.

Let's look at the portfolio in a bit more detail starting with some perspectives on RMBS holdings. We determine fair market values for RMBS securities using market pricing data and we compare these calculations to results from internal pricing models which reflect a current evaluation of the quality of underlying collateral. Based on our experience we believe that analysis of the underlying collateral is more indicative of the intrinsic value than market prices. This is because market pricing is based on very limited trading information.

Based on these analytics the value of the RMBS securities backed by Alt-A and subprime collateral is $2.4 billion at book and $1.7 billion at market. For monitoring and management we have divided this portfolio into three parts.

First, securities with an unrealized loss where we are comfortable with the performance of the underlying collateral. These securities have a book value of $2.2 billion with net unrealized losses of about $700 million.

Second, securities where we identified a credit-related impairment because they failed cash flow testing in the quarter. These credit-related impairments totaled $121 million after tax for the second quarter and they were concentrated in holdings that had been downgraded to below investment grade. The book and market values of these securities now total $104 million.

And third, securities where collateral cash flow testing was adequate but where our quantitative and qualitative risk assessment indicated a higher risk profile than we desired. Here we recorded a change of intent related impairment of $215 million after tax for the quarter. In general these securities are rated below the A category.

The book and market value of these securities now total $61 million. We will be monitoring these securities closely and we will be opportunistic if the market improves. Adding this up, we are certainly not pleased with the level of impairments in the RMBS portfolio; however, we do feel that we have taken prudent action to segment the portfolio and take a more conservative stance.

Shifting to the corporate bond portfolio, we are trimming holdings in a number of areas that are more sensitive to consumer discretionary spending and selectively reducing financial sector holdings. I will note that we have approximately $170 million in Fannie Mae and Freddie Mac debt, the vast majority of which is senior debt. We also have about $130 million in preferred stock.

Next, I want to review our cash position which did increase during the quarter. The holding company had $1 billion of cash and short-term investments at June 30th, including the proceeds of $600 million of debt issued in the quarter. This is held as pre-funding for 2009 debt maturities and as capital available to support both holding and operating company cash flow needs. We temporarily increased cash positions in our US life companies to tighten near-term asset liability matching and to fund new fixed income investments in attractive sectors.

Finally, let me touch on our commercial mortgage-backed securities. This $4.9 billion portfolio is well diversified and the average loan to value was 60% at origination. To date we've seen the collateral performing in line with original underwriting and pricing expectations. The isolated impairments we have seen relate to loan extensions on securities purchased at a discount and where there is no current expectation of principal impairment. We would expect this trend to continue.

To sum up, we are proactively taking steps to manage risk and defensively position the investment portfolio for this credit cycle and to capitalize on opportunities in the current market.

Turning to capital, maintaining financial flexibility and capital to support our AA category financial strength ratings are key priorities for Genworth. In our US life insurance companies we target risk-based capital ratios of greater than 350%. In our mortgage insurance companies we target risk to capital ratios based on rating agency risk-adjusted capital requirements. We build in additional cushion to provide for a variety of market conditions and/or rating agency methodology changes.

With that in mind I'll review actions we are taking to efficiently manage the capital position for each of our three operating segments. Starting with US Mortgage Insurance, we are executing plans we discussed in January to maintain target risk-based capital levels without committing additional funds from the holding company. These plans also included positioning our US Mortgage Insurance company to participate in incremental new business growth funded by external capital.

During the second quarter we completed a transaction that created an additional $110 million of capital capacity through a reduction of risk and corresponding required capital. We continue to explore additional transactions to provide capital flexibility given the US mortgage insurance losses we are seeing. We are also actively engaged in a number of potential reinsurance transactions that would provide an additional $200 million to $400 million of new capital to fund growth opportunities over the next couple of years.

Turning to retirement and protection, we have outlined plans to extract about half $2.8 billion of capital trapped in low return life insurance, long-term care and annuity blocks over a multiyear period. To date we have made good progress toward completing a combination of related reinsurance transactions which are designed to enhance our capital position. Executing these transactions would meet our 2008 objective for freeing up capital from low return blocks.

As you know, we've used securitizations to fund additional universal and term life insurance reserves. Since late last year, and given the lack of liquidity and securitization markets, we've completed reinsurance transactions to fund some of these reserves. Reinsurance provides a good alternative in the near term while over the longer term we expect conditions in the life securitization market will improve. In sum, although retirement and protection has seen the impact of higher impairments, these various capital initiatives enhance our capital flexibility.

In our international segment, where we have been adding capital to fund strong growth, the market is slowing. The global decrease in new mortgage originations has resulted in a corresponding slowdown in Mortgage Insurance growth. This, coupled with the favorable loss trends we are seeing in Canada and Australia, decreases the capital required internationally. Over the near term these international mortgage insurance companies are expected to become a source of capital.

Adding this up, we have good capital plans in place across the Company. We've made solid progress to improve flexibility to navigate this difficult environment. And we expect to end the year with solid risk-based capital ratios and risk to capital metrics along with $300 million to $600 million of deployable capital consistent with our capital plan. With that I'll open the call for questions.

(OPERATOR INSTRUCTIONS). Andrew Kligerman, UBS.

Good morning. Two questions. Pat, that was a really interesting review of capital. And perhaps you could give us a little math on how you originally had expected $300 million to $600 million in excess capital by the end of the year. Maybe give us a little more color on how you're going to get to that number more specifically? And also, these capital charges from realized losses or impairments as you well -- how are they going to affect it?

And then just to Michael, a question -- you're effectively going to change the USMI pricing, I guess that's effective in July. You put $14 billion plus in new insurance written on the books in the US. And I think you are touching on it in your presentation earlier, but if prices are going up 20 plus percent on this new plan, what is that telling us about the business that was recently put on? What kind of returns can we expect from that?

Great questions, Andrew. Let me just turn the first two over to Pat and then I'm also going to ask Kevin Schneider to comment on our USMI new business. Pat?

With respect to our original capital math or capital walk we were looking at generating a certain level of expected statutory income, investing a certain amount in new business. I would say that what's happening with the impairments that we've seen, and I'll just give you a couple of figures -- in the first quarter of '08 we had statutory impairments of $73 million; in the second quarter of '08 we had statutory impairments of $87 million.

We're seeing a little bit of extra pressure relative to our expectations through impairments and through some -- I'll say some difficult, challenging growth markets. But when you look at our original capital plan, we had planned capital actions to extract capital from low return blocks of about $500 million. The transactions we're working on are already targeted at that level. And in addition we had provided for fairly significant share repurchases over the balance of the year.

And what we have said is, depending upon how these things work out, our efforts and our success in extracting capital from the low return blocks, combined with keeping an eye on the developing impairments and developing statutory earnings, we would then later, probably at the end of the third quarter, take a close look at the share repurchase and we would make a decision accordingly. So we think that based on the actions that we've taken, based on the way we originally set out the capital plan, we have the flexibility to get there albeit it may not be exactly how we laid it out originally.

Let me catch your last question there, Andrew. This is Kevin. The pricing increase that we did announce at the end of the last quarter does go into effect effective July 14th, so we're a week into that. And that will certainly provide additional cushion in what is a very uncertain mortgage market. But what we feel really good about is the overall developing loan characteristics of the book of business that we've been putting on.

I'd probably characterize that the early part of the quarter probably had a little bit of carryover and pipeline clearance from the end of 2007, but in the main we've eliminated the Alt-A, we've eliminated the A-, we're eliminating most of the 100% loan to value product; our debt to income ratios are coming down on the business we're doing; the credit levels of the borrowers that are insured are rising; our overall LTVs are coming down. So literally every week of production we're seeing improving composition and loan characteristics in the business we're writing.

So I would say that as we go forward through a combination of our guideline changes, our pricing, the declining markets approach that we've taken, we really feel this book of business in total is going to be a profitable book of business 2008. And as the pricing continues to feather in this overall book will have room for a rise in overall ultimate claims rate -- higher than what we expect and still produce accretive ROEs for our business.

Dan Johnson, Citadel.

Thank you very much; I appreciate the improved disclosure in the release related to the MI business in the supplement. Can only go to the -- there's a page where we go through the captive arrangements and, again, very good disclosure here. One of the things that I think we'll be interested in watching over the next couple quarters is the progression of the attached portfolio as it works its way through, or potentially through, the captive arrangements or I guess you'd call it going out the top end? What can you tell us now about where we are with some of these books of business in that? And really importantly, where do you think we end up in terms of how much dollars come out the top end?

Dan, this is Kevin. The first thing to think about is the development of those in terms of coming out the top end is very highly dependent on the nature of the structure that was entered into in the first place. Those that had lower ceded premium levels had a lower ultimate top tier of the attachment and those are likely to be more pressured as the 2007 and '06 books develop.

At this point in time, while it's too early to definitively forecast how that 2007 book is going to perform in this environment, the acceleration so far in terms of delinquency development, the incurred losses and the captive development as well can lead you to believe that some of the 2007 lender captives could exceed their tier.

I would say we believe that some of the 2007 -- '06 captive books could be also pressured, but I think the real question is going to be what's the level of materiality around the pressure? Ultimately as they do come out the top end of the captives where that might occur, we would expect our earned premium growth to be able to absorb those losses that would come back to Genworth and we think they -- and largely should be very manageable.

But again, the ultimate development is really going to depend upon continued delinquency progression, the geographic and product concentrations, what's going to ultimately happen in terms of lapse and cure rates, and the impact of our loss mitigation efforts. But at this point in time we would believe that to be manageable.

And on that issue of sort, as you said, depends on how the underlying business is doing. Maybe we can talk about the severity progression. The delinquency progression obviously moved up a good bit, but unlike what we've seen at some other companies -- well, not that many have reported yet, but at least a few. The severity component continues to move up meaningfully. Can you sort of point to some of the sources of that and, importantly, how long do you think we'll be looking at rapidly increasing severity rates? Thank you.

When you refer to severity, I think I'm interpreting that as average claim rate.

Correct.

If I'm following you correctly.

Yes, it was up about 20% sequentially to that 19,000 number.

The growth in the dollar amount of the average claim rate is obviously being impacted by, in particular, those four states that had the highest loan levels or the highest property levels, those states that are providing the most increase in our delinquency development, so California, Florida, Nevada and Arizona. We should expect that in terms of those claims rates to continue to be pressured as those delinquencies work their way through the system.

In terms of thinking about how we historically talk about severity, severity is going to -- it's going to move around really region by region. At this point in time our severity level for the quarter came in at about 103%. Up a little bit from the first quarter at 102%, but again just to remind you, we believe there's a structural limitation on that that's really based into our ultimate claims obligation levels and the coverage that we provide. So we feel good about where that is right now and it's well within the range that we assumed in terms of our severity assumptions.

So the movement from quarterly severity of just a couple percent in last year and now we're looking at mid-25% sequential severity, that was expected?

Well again, you've been talking about ultimate claims dollars, average claims dollars. We absolutely, based upon the development and the emergence of delinquencies in the third and fourth quarter of 2007, as those loans began to go to delinquent and particularly being driven by the higher loan balance states, then we did have an expectation that ultimately those delinquencies that went to claim would drive a higher average claim amount.

Thank you very much.

Darin Arita, Deutsche Bank.

Good morning. A question on the investment portfolio. Can you give us a sense of what percent have the Alt-A and subprime RMBS exposures been written down based on their original ratings, in particular your A, BBB and below tranches?

Let me turn that over to Pat. Pat?

I would say that at this point in time the vast majority of the impairments we've recorded, including the change of intent related write downs has been related to securities which were originally in the A and BBB category with minor, I'll say some, invasion, not a large number of claims into the AA. Does that answer your question?

I think so. I guess if I looked at what you had originally rated A and if you still held that security now would it be fair to assume that your carrying value at this point is almost zero?

Our carrying value would be consistent with the market values which are steeply discounted from kind of the original amount of the obligation.

Okay. And as you're shifting the investment portfolios you talked about today, what sort of affect should we expect that to have on your investment yields?

I would expect that as we start to employ the relatively significant cash balances we're holding and look for opportunities to invest in the current market with, I guess when you look at the 10-year treasury being 50 basis points over what it was at the end of the first quarter, corporate spreads being at relatively wide levels, probably consistent with what we saw at the first quarter, we see opportunity to increase our return by deploying those funds.

Okay, great. And then just one last question. On the mortgage insurance business, I'm kind of wondering how's Genworth applying the lessons it's learned on the US mortgage insurance business so that it can stay ahead of the curve on the international business?

I'm going to turn that over to Tom because, as you can imagine, first of all we thought about that for a long period of time and we're quite active on, first, sharing things we have learned down through every level of the organization talking about product, talking about underwriting all the way through the process including your operations and monitoring. But Tom, do you want to pick up on also how different the international business is again as far as design versus the US market?

Exactly, Darin. And again, a great question. As we've talked about on some prior recalls, you also heard this morning, while the international markets are very, very different from the United States, particularly from the perspective of the nominal amounts of nonprime and nonstandard products, and as importantly, their reduced reliance on mortgage-backed securities that actually drove a lot of the nonstandard products in the United States.

So while the markets are different we've also tried to look at the United States' markets and have actually worked with many international regulators and others to make sure that a lot of the issues we have here have not been repeated.

So in addition to looking at the performance of certain products like 100% loan to value and others and while we had nominal positions of those internationally we've pulled back. We've always looked at areas that could be recessionary sensitive and since we've, again, seen what's happened in the United States we've pulled back.

But as importantly, I think the real international story is what I had mentioned to you earlier, and that is that the world has watched the United States and there have been some pretty aggressive thoughts not to let some of the issues that we have encountered here migrate or matriculate, if you will, to those environments.

And you may have seen, as an example, the Canadian government's actions to eliminate the guarantee on certain mortgage loan products. It was a terrific move, there are nominal high-risk products in Canada, but they literally did not want to see the migration of what was in the United States to Canada. So we constantly share our best practices and it goes beyond the best practices internally, but we're also using it externally as well.

Great. Thanks very much.

Ed Spehar, Merrill Lynch.

Good morning. I have two questions. I guess first for Mike. You're maintaining your earnings guidance and I think you said something along the lines of you have more visibility into the MI outlook than you've had at any other point during this crisis period for housing. And so I guess my interpretation of this, first of all, is that the USMI loss range that you gave us last quarter for the year of $100 million to $200 million really hasn't changed. So I guess I'd like you to tell me if that's correct.

And then related to that, I know you're not going to give us an '09 number. But given sort of the visibility, are you comfortable enough today with the outlook to say that the trough should be sometime late '08, early '09? And then I have one quick follow-up.

First, in answer to your first question, yes, we remain in the $100 million to $200 million loss range on USMI. Sort of interpreting and expanding upon your second question -- here's how you can sort of think about the year. If you annualized the second-quarter reported year to date you're sort of right -- just above $900 million. On top of that, if you look at a tax rate of around 27% of the year you're going to add about 45 on top of that.

If you look at some improvements we anticipate on the investment front, that has an opportunity for the low 40s. If you look at second half USMI, because of the captive impact, also, as I mentioned, we would expect to get some captive benefit on that '05 vintage second half versus the first half, we'd anticipate around a plus 50. And then you have business growth, you have cost savings, that's a range of $35 million and that's how you can see a path. And there's going to be some variance on individual items right into that range.

Now you're right, I'm not going to give you a view on 2009 and I would like to stick with the plan giving you a directional look at our next earnings call which should be towards the end of October with a more comprehensive view in December at an investor update.

But you can see what we're doing quite diligently to change the USMI business model and do everything to have smart growth on the one hand; manage risk really well like our declining markets, policies and stringent underwriting; and dealing with the realities of some of the underwriting practices we saw particularly in portions of that '06 and '07 book; and be intently focused on loss mitigation including investigations. And you add that up, we think that's the right steps to take for that business to position it for the future.

And Mike, just on the $50 million plus that you said in the second half and the USMI, I think you said the captive -- what did that refer to?

I'm just showing you the difference over annualizing first-half versus second half.

Okay. So you're saying additional -- okay. And then just the final question was --.

That type of thing would put USMI in sort of the midpoint of that $100 million to $200 million loss number that I gave you.

Okay. And then the final question is you had a small net loss this quarter because of the impairments and the realized loss. What do you think the chance that you have the net loss, forgetting about operating, that you have a net loss in the second half of the year?

I think Pat has dealt with the rigorous approach that we've taken to the investment arena. Of course it remains a dynamic market, but when you think of where the impairments we took came from, they certainly come from the portions of the portfolio that we thought had the most risk. Pat, any other thoughts on that?

To give you visibility on that, I think it's important to provide some clarity on what our gross unrealized loss position is. And you'll see this when the Q comes out. But we currently have gross unrealized losses of approximately $3.5 billion. We've got about $1.9 billion of that related to corporate and $1.5 billion of the remaining in structured. So that's virtually all of it.

So generally the unrealized losses in corporate reflect recent interest-rate increases and the economic conditions that have resulted in spreads widening through year. And I'd say in addition we're monitoring individuals' names and we've impaired -- what we've concluded we will not receive full interest in principal payments on.

You look at the $1.5 billion in structured, we've concluded from the quantitative and qualitative analysis that the $0.7 billion component in subprime and Alt-A is performing well and the remainder is a combination of prime agency, ABS, CMBS for which the underlying collateral is actually performing better.

So we think that we've been conservative, and appropriately so, with how we've handled the investment portfolio and the risk profile. So I'm looking at the future quarters with a much different expectation for investment results and I feel good about that.

Thank you very much.

Steven Schwartz, Raymond James.

Good morning, everybody. Kevin, could you help here a little bit? You mentioned the reinsurance structure that you put in this quarter, that you're looking at others. Could you describe those, please? And I'm also interested in trying to get a handle on how much business you think you could write in the US without any structure in place?

Steven, we did not implement any new reinsurance structure within the US mortgage insurance business.

Oh, you did not?

You may have been referring to -- we did create some added capital cushion by redeploying some assets that were invested in sort of a high capital charge position and we redeployed those assets into a lower capital charge position. So too Pat's comments, that created a little over $100 million worth of capital flexibility for us.

Okay, I didn't understand that. But you are looking at some structures, is that correct? Did I catch that right?

We absolutely continue to evaluate structured opportunities that would create additional capital cushions for us, give us the ability to perhaps expand our writings through some of the support of that additional capital. And that capital, again, could come from an outside insurer or from other sources as opposed to our own equity.

So a sidecar?

A sidecar type approach, yes.

Okay. And given -- let's assume that doesn't happen, what kind of run rate of business could you write?

We think we're adequately positioned right now to continue to write at our current market penetration and share levels. The additional flexibility is prudent in this environment and we think about it in terms of the need to be able to take up some additional production and penetration as we go forward and as things develop in the marketplace.

Okay. Pam, I'm sure you're just sitting there all alone. Could you maybe touch on your business? Obviously it's not as key in the current environment I guess as worrying about the other issues that we're worrying about, but your business didn't look all that good. Maybe you can touch on maybe some of the highlights of what's going on there?

Is there any specific area you'd like to overall discuss?

I thought fee-based was kind of weak; I thought the spread-based business was kind of weak. You mentioned in long-term care that -- I think on some older blocks of business that you were still seeing some morbidity issues; maybe you could touch on those?

Okay.

Or maybe you disagree.

Let me walk through the fee. Yes, we had an $11 million drop in our fee-based business, but what I want to first say on our fee-based business, if you look at our underlying growth in assets under management, the underlying core fundamentals of income would indicate that our income levels should be tracking that. But let me walk through the fee-based and the deterioration that you saw, the $11 million.

$3 million was attributed to the taxes on the impairments. As we discussed at yesterday, we are seeing -- and this was disclosed at investor day, $3 million of earnings from fees from GE that are nonrecurring. In addition, there was $3 million of reclassification of our hedging costs from gains and losses to operating income. So that's a geography. And then a $3 million one time DRD adjustment.

And then, if you look, we had about $5 million of earnings growth just from the AUM increase, but that was offset by the market performance, the overall market performance. So I want to reiterate on fee, if you net out these adjustments and our overall growth in AUM our earnings would have tracked to that. But it is a lot going on.

On spread-based, the drop there largely due to investment yields and floating rate assets and a decline in yields and (inaudible) -- and tax from the impairments of $12 million. On long-term care, that's pretty simple. If you take out the one time bond call from last year of $9 million, there was roughly a 6% increase in earnings.

Okay. And you mentioned morbidity; there was nothing there, that was just throwaway line?

No, that was in line with our expectations. And the increase, the $6 million if you take out the bond call, driven by new business growth and expense productivity.

Okay. And the rate increases should be hitting shortly, no?

Yes, we would expect to see that coming through in the last half of the year.

Okay, thank you.

Eric Berg, Lehman Brothers.

I would think that in order to prevent a recurrence of the difficulties that you and others have experienced in mortgage insurance, that it can't just be a matter of raising prices or getting out of specific product types as Kevin mentioned. Because there is always a risk that what you do next is going to be your next mistake. In other words, I'm thinking that in order to prevent a recurrence, there has got to be a change in how people think when they come in to work each day in general about, in broad sense about approaching the business; about what housing prices will do, about the quality of underwriting.

What are you doing -- my question is what are you doing to sort of -- the question is purposely general -- change people's general approach to doing business in this business to prevent recurrence? I know my question is a little bit fuzzy, but I hope the main idea is coming across.

Eric, it is Mike. Let me give you a couple of perspectives and then I'll hand it off to Kevin to provide I'm sure a more detailed perspective. I think we have been pretty clear that we have challenged every aspect of the business model, and you do have to use all of the levers that you talked about and more.

You do have to look at product. You do have to look at underwriting. You have to look at lenders and their practices and what businesses they are in and not in. You have to look at how you make assumptions of the geographic submarket level going forward. And the analytics, I think we have all learned some things about analytics and being able to even sharpen more loss predictive capabilities.

You have to look at prices. You have to work on the regulatory environment too, because there are certain things that have to go on in the regulatory and, for example, lender audit environment that are important as well. You have to look at the secondary markets and, therefore, again what are the GSEs doing given that is where mortgage insurance still tends to attach and what business do they accept, and how are they looking at risk.

So you have to look at all of those levers, and we have in every one of the moves that we have been describing over the past couple of quarters. Taking it even deeper within the business, Kevin, do you want to build upon that?

Just to build upon it a bit, we need to -- we have charged our business and challenged everybody across our business to create a higher return business model with reduced volatility. One of the ongoing realities of that reduced volatility and being able to execute that and consistently deliver upon it is that you see us shifting back and becoming a core product type business. A core product business that is going to maintain our credit standards through cycles.

We will be really focused strategically on becoming the most efficient and profitable manager of low down-payment risk and that requires a number of changes to the way we think about things, to Mike's point, from underwriting up front to bringing it in the business, to our portfolio management, to our risk disciplines, to our audit functions, to the way we deal with commercial relationships which is all going to be geared around and designed around that reduced volatility and that higher business return.

So you're absolutely right, this is a different environment. It's just not about changing a few things in terms of what we ensure, but it's about taking an organization now who's going through and living with the realities of this cycle and making sure that nobody -- that collectively everything we do in all of our activities tied together don't allow us to drift back to this in the future.

Additionally, it's not just organizational, it truly is going to require continued regulatory change and we're very focused on that as well. We're very pleased this morning with the President's signage of the new housing legislation, the benefits that's going to do in terms of shoring up the GSEs and bringing in an effective regulator. That's all good for business going forward and we feel very favorable about that, as well as continuing to work with bank regulators so that they continue to reinforce this return to this type of underwriting standard that we think is so important.

Kevin, one final question. We've talked repeatedly about the four states that are at the center of this storm, but it looks from the delinquency data in your supplement that you're getting sharp increases; admittedly you have a much smaller business in the Northeast and -- pardon me, New England and the Mid-Atlantic states. My question -- is this housing crisis a narrow crisis or is it now everywhere in America?

If you step back away from the development, when I think about our -- to answer your question, it is still largely centered, in terms of the impact from the specialty products and from the price declines, on those four states. They continue to drive a tremendous amount of all of our reserve strengthening; they've managed to be the drivers of our new [office] development. But there is no doubt that the housing crisis is expanding to further parts of the country.

We are seeing some increases, as you mentioned, in the Northeast, in certain states in the Midwest or -- excuse me, Mid-Atlantic, yes. But when we step back and look at what's really driving our delinquency development right now, our total core business outside of those states is still holding up very strongly.

Just to give you some flavor for it, our core -- what's driving some of the, outside of the specialty products in those four states, our core business is really holding up well. And if you take those four states out of it, our delinquency development there has been effectively flat over the last three quarters, bounced around a little bit, but it continues to be driven by those states. But this is not just a unique housing situation for those four states.

Thank you very much.

Tom Gallagher, Credit Suisse.

Good morning. Just a couple of questions for Kevin as well. The first one is on your comment that some of the '07 captives may exceed their tiers. Can you give a little perspective on that in terms of are we talking about a meaningful percent of the '07 book or is it going to be fairly limited in terms of how much of it?

And then the second one is also on the delinquency trends, I appreciate the new disclosure which shows by FICO score and by book year. And if you look at the '07/'06 books you're seeing delinquency trends going up on some of the higher FICO scores. Can you give also a little perspective on what you're seeing there? Do you expect continued escalation on the higher-quality book? Thanks.

Okay. First on captives, Tom. The 2007 book is simply there's been an acceleration of the attachment of those captives as the delinquencies and the reserving against those delinquencies has escalated those captives. That will simply bring forward the overall benefit of those captives into -- that will be able to be recognized in earlier periods. The captives that had a lower top-end attachment level will, in all likelihood, be those that are most pressured, but there will be pressure on the others and it's all based upon how much geographic and specialty product content in general was within those individual lender captives.

Again, we believe that the pressure to the upper end of those captives will be manageable. It's far too early to call what the ultimate development is going to be. It's going to be largely dependent on and how these things ultimately develop and the overall loss mitigation efforts of the entire industry against this challenge. So to give you further visibility into it beyond what we've provided in our disclosures, I really can't.

Just a quick follow-up on that. So I presume then it would be more isolated to the captives that have the 10% on the top end. And can you just remind us what percent of your total --?

If you think about it, those captives that had a 10% upper loss tier, any business that's -- if that entire book ultimately performed at a 12, it's going to be outside that tier. That's just the way you need to think about it. Those captives that had an upper 14% loss tier have more room within the captive and at a 12 those will stay within the captive.

In terms of our percentage mix of how many of them were in the deeper cedes -- 30% -- I'll have to get back with you on that, Tom. We'll give you a follow-up answer on that off-line. Turning to your discussion around delinquency trends and developments, I'm trying to get back to what it was, if you would remind me what the second question was again?

Sure, just --.

Oh, the higher FICO, excuse me.

Yes, the higher FICO delinquencies.

In our disclosure, this is a document that we've been sharing for the last couple of quarters on some of our investor websites. It's really to try and give you as much transparency at a book year, at a FICO basis as well as at some alternate product cuts. There is some deterioration you see in some of the higher FICO ranges. I think what you'll probably see is that it's really being driven by more the adjustable rate product.

The adjustable-rate product is -- compared to the fixed-rate product is certainly suffering a higher delinquency level across all FICO scores. You're seeing it also again in the Alt-A product, that's another big driver of it as well as in some of the other interest-only and option arm pieces. So I really think that's where you see it.

And in those four states, when the four states are suffering pressure it doesn't matter exactly what your FICO score is if you're suffering from that. And I -- so the regional pressure on those four states is probably the other big driver of that level.

Okay, thanks.

Suneet Kamath, Sanford Bernstein.

I guess two quick ones for Pat. First, on the securities where you've indicated that you no longer have an intent to hold to recovery. Sort of going forward how are those securities treated in terms of mark to market? Are they treated like trading account assets or do they still sit in the available for sale? That's the first question.

Then the second question relates to your variable annuity business. I guess based on conference calls that we've heard so far this quarter it seems that the life sector is kind of split in terms of how it treats the impact of the equity markets with respect to variable annuity DAC amortization with some companies truing up every quarter, other companies holding off until a third-quarter DAC review. Can you just remind us which side of the fence you guys are on? Thanks.

Okay. For your first question all of the assets that we have on the balance sheet are mark to market and the difference is how you handle these in terms of accretion going forward. And what we would do is we would accrete these securities to our expectations of interest and principal recovery and those would come through investment income for each period.

But is that also on the securities that you basically are holding for now, but you plan to sell them? Those don't get reclassified as trading accounts?

I'm sorry; they would remain as available for sale.

Okay, thanks. And then on the DAC?

On the DAC question, we do a rigorous analysis every quarter and you could say that we do true-ups for DAC if there's minor fluctuations each quarter. And if there were a more significant change in the market then we would do a full unlocking.

Okay. So no reason at this point to expect a big unlocking in the third quarter based on the markets that we've seen so far?

I would not expect that based on what we've seen so far.

Thanks very much.

Jeff Schuman, KBW.

Good morning. A couple follow-ups on capital. Pat, when you were talking about capital targets in the insurance operations, you mentioned there that you have to manage to a number of constraints, but on the life side you are able to give us kind of 350 RBC is kind of one benchmark to look at. On the mortgage side is there any kind of benchmarking you can point us to or range of kind of risk to capital or something that we can think about there?

I'll handle the first one on the mortgage side, Jeff. Our reported risk to capital at the end of the first quarter was a little over 13 to 1, that will probably feather in a little -- about at 14 for our second quarter, well below a 25 to 1 statutory minimum requirement. So we really feel that given our pricing approach and our current product mix we'd expect to be able to operate comfortably in the mid to upper teens for a targeted risk to capital level over the next several periods.

The other thing to remember on that I think, just a comment, is risk to capital is only one measure of capital adequacy and it really doesn't differentiate between the risk profiles of the underlying collateral. And put another way, our risk to capital on a relative basis is on a lower risk profile.

Okay, that's helpful. And has there been any change in terms of a rating agency thinking about the statutory contingency reserves? I mean, those basically have sort of been treated as capital and does that continue to be the universal view?

This is Pat, I'll answer that. The rating agencies basically look at the total available capital in the Company, like all of the resources you have to satisfy obligations, and then compare that to the stress capital requirements in their models and that's how they get there. So they don't really look at the contingency reserve separately, it's kind of an all-in picture.

Okay, thank you. And then one other clarification. I think Kevin had talked about reinsurance transactions on the MI side. And Pat, I think you talked about using reinsurance support for [XXX] release. But as you kind of manage capital in this period are you using coinsurance or other increased reinsurance tools onto the life and retirement side to manage capital?

The answer to that question would be, yes.

And is it sufficient that we need to think a little bit about the impact of net top-line growth into '09 or not that significant?

The way that I would look at it is you could look at these as reinsuring of relatively low return low risk blocks and therefore the financing charge for funding the capital for those blocks is economic, and so it has a lesser impact than you might otherwise expect for traditional coinsurance.

Jeff, Mike. Just again, I just want to make sure our strategy is well understood is using -- we have one, and I'm talking now within retirement and protection and thinking about the life, the annuity blocks, also we've talked about (inaudible), is one is to use either capital markets for reinsurance to free trapped capital from lower return blocks, and that remains a focus. The focus now is on using reinsurance in the current markets.

So consistent strategy, a different mechanism to do it and we've seen more reinsurance opportunities over the past several months to do so. Remember the second strategy, as you point out, AXXX, XXX, is you have the additional reserve levels and funding those additional reserves for capital efficiency we have also seen move from the securitization markets to the reinsurance markets. So those are the two ways to think about it vis-a-vis retirement and protection.

That's very helpful. Thank you.

Mark Finkelstein, FPK.

I'll make this quick. Just a couple of follow-up questions on the targeted deployable capital of $300 million to $600 million at the end of the year. I guess the first question is does that assume kind of a capital cushion or capital margin over the 350 RBC and your targeted metric on the USMI? And if so, how much capital above that is in that $300 million to $600 million kind of number?

It does assume a capital cushion that we've built into our standard capital charges and capital plan. And on the life side that's like in the $200 million to $300 million range. And we have a similar number on the mortgage and insurance side, but it varies from time to time. So I'll say like a $100 million to $400 million range.

Okay. So the $300 million to $600 million is above those cushions?

Yes, it is.

Okay, perfect.

And then consistent with the -- I believe the presentations we did around investor day or year end.

Okay. And then secondly, just on the $1.4 billion of capital that you expect to be freed up in life and annuities over the next couple years, I guess how much of that is budgeted for '08 to be included in [this DAC] capital at year-end as part of that capital analysis?

I'm sorry, I'm not sure I understood. Could you ask that question again?

Part of the capital plan is to free up $1.4 billion or half of the $2.8 billion of trapped capital through reinsurance or other solutions. And how much do you expect to get freed up this year and that is part of the capital plan and what you're expecting at year-end in terms of capital?

Yes, $500 million.

Okay.

Does that answer your question?

Yes, it does. And then the only other thing I was going to ask real quake is Hartford announced on its call yesterday a change in the statutory way of estimating kind of impairments from going from an undiscounted cash flow to a discounted cash flow, unstructured securities and they estimated that it would have a pretty decent kind of capital impact. Have you guys done the analysis on that if it's implemented and how much does that impact statutory capital?

Yes, we have done the analysis and our estimate is $200 million.

$200 million. Okay, great. Thank you.

Ladies and gentlemen, this concludes Genworth Financial's second-quarter earnings conference call. We thank you for your participation. At this time the call will end.