Genworth Financial Inc. (GNW), the mortgage guarantor and life insurer, placed a derivative bet in the fourth quarter that added almost $1 billion to investments and increased the risk of collateral calls if interest rates rise.
The company settled profitable hedging contracts and replaced them with new swaps featuring lower strike levels, Richmond, Virginia-based Genworth said today. The firm said it collected $950 million from counterparties and invested the funds in holdings expected to generate about $20 million a year.
“What we did in effect was say, ‘Rates have come down dramatically, let’s lock in that gain today,’” Ronald Joelson, Genworth’s chief investment officer, said in a conference call with analysts. “The give-up is, you recognize that under the higher-rate scenarios that could ensue in the future, that we would have to post collateral.”
Genworth tapped its hedging program for cash as the company’s unprofitable U.S. mortgage-insurance business hurt results. The Federal Reserve has kept interest rates near zero, and said last week that economic conditions may warrant “exceptionally low levels” for rates through later 2014. The U.S. unemployment rate dropped to the lowest since February 2009, Labor Department figures showed today, casting doubt on the Fed’s plan to keep rates low.
“The risk is they get burned by higher interest rates,” said Edward Shields, an analyst at Sandler O’Neill & Partners LP. Genworth “may be making a bet on having such an improved capital position long-term from now that they can simply unwind the swaps at that point if it goes against them materially.” Shields has a “buy” rating and $9 price target on Genworth.
Genworth posted the biggest gain in the Standard & Poor’s 500 Index today after swinging to a fourth-quarter profit on fewer claims tied to delinquent borrowers. It rose 14 percent to $9.17 at 4:15 p.m. in New York. The company, which fell 50 percent last year, has gained 40 percent since Dec. 31.
Genworth uses swaps to protect its insurance business from rate declines. Derivative hedges have produced gains for companies including MetLife Inc., the biggest U.S. life insurer, as bond yields slumped over the last year. Genworth held more than $12 billion of interest-rate swaps at the end of September, according to the company’s third-quarter report.
“We have to be very careful that in higher interest-rate environments we also have sufficient collateral to post,” Joelson said. “We are reinvesting in very high-quality assets that would be eligible for collateral.”
Net income in the three months ended Dec. 31 was $107 million, or 22 cents a share, compared with a loss of $161 million, or 33 cents, a year earlier, Genworth said late yesterday. The U.S. mortgage-insurance segment’s loss narrowed to $94 million in the period from $352 million a year earlier.
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