* Q4 EPS operating loss 28 cents vs Street view 16 cents
* S&P cuts mortgage insurer to junk status
* CEO says no split now, but possible in future
* Buybacks or dividends two to three years out
* Shares fall 11.3 pct to early December low (Adds S&P downgrade, updates shares)
By Ben Berkowitz
NEW YORK, Feb 2 (Reuters) - Insurer Genworth Financial Inc (GNW.N) reported a surprising loss on Wednesday, as problems in its mortgage insurance business deepened and the company saw little sign of them letting up this year.
The company also said it considered splitting itself up, but rejected the idea -- though it remains open to it in the future. Absent a split, Genworth said it was probably two to three years from being able to pay dividends or buy back shares as some prominent investors have demanded.
Genworth shares fell 11.3 percent in early afternoon trading to their lowest level in two months.
Standard & Poor's downgraded Genworth's mortgage insurance subsidiary GMICO to junk status and said there could be further downgrades in the future. The business had already been forced to seek waivers from state regulators to write new business because it was on the verge of breaching a key capital ratio.
The company boosted reserves in its mortgage insurance business by $350 million before taxes in the fourth quarter to account for rising claims. That pushed the unit into an operating loss more than double that of the third quarter and nearly five times larger than what it reported a year ago.
"The U.S. (mortgage insurance) recovery is slower than anticipated and included some disappointing surprises," Chief Executive Mike Fraizer said on a conference call.
A decline in the amount of money saved from efforts to modify loans, withdraw policies and settle disputes with lenders amplified the losses.
Genworth, historically one of the five largest U.S. mortgage insurers, reported a 26 percent decline in mortgages modified through the federal government's Home Affordable Modification Program, or HAMP. Modifications through other programs fell about 10 percent.
A little less than half of the addition to reserves in the mortgage business was due to the impact of that decline in loan modifications in the quarter. The rest came from lower expectations of future success in fixing delinquent loans.
S&P equity analysts cut their 2011 earnings estimate by more than a fifth and trimmed their price target, but backed the move to add to reserves.
"While we are discouraged by the continued poor results at U.S. Mortgage Insurance, we think (Genworth) has taken proactive steps to reserve for future losses, and see the company benefiting from loss mitigation efforts," analyst Bret Howlett said in a note.
While the number of new delinquencies in the quarter was the lowest in the last two years, the number of claims that were paid out rose for the fifth quarter running.
There was even evidence of delinquencies in new lending. Some 1.8 percent of loans made to people with low credit scores in 2010 were late at Dec. 31, the company said.
Given the troubles in the mortgage insurance business, Genworth executives said they had considered the possibility of splitting it out into a separate company.
While they have rejected the idea for now, in part because of tax risks, they said on Wednesday they remained open to the idea if it proves to be a better option in the future.
In the meantime, they said they would look at returning capital to shareholders. Prominent investor Steve Eisman, on a conference call in October, threatened a proxy fight if they did not buy back shares. Eisman could not be reached for comment on the latest developments.
Genworth reported a net loss of $161 million, or 33 cents per share, against a profit of $40 million, or 8 cents per share, a year earlier. On an operating basis, Genworth lost 28 cents per share. Analysts polled by Thomson Reuters I/B/E/S expected earnings of 16 cents.
The losses in the mortgage unit more than offset small gains in Genworth's two other business lines, retirement services and international operations. (Reporting by Ben Berkowitz. Editing by Dave Zimmerman, Robert MacMillan and Tim Dobbyn)