Principal Financial Group, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. Financial statements are unaudited. Amounts are in millions of dollars except per-share data.
Business context
Principal provides U.S. retirement and asset-accumulation products, global and international asset management and accumulation services, and U.S. life, health and specialty-benefit insurance. Its reportable segments are U.S. Asset Accumulation, Global Asset Management, International Asset Management and Accumulation, Life and Health Insurance, and Corporate.
Financial performance
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Total revenues | $2,233.6 | $2,157.8 | $4,497.6 | $4,346.4 |
| Income before income taxes | $157.8 | $197.9 | $414.1 | $328.0 |
| Net income attributable to PFG | $142.3 | $158.6 | $341.3 | $279.6 |
| Net income available to common stockholders | $134.0 | $150.3 | $324.8 | $263.1 |
| Diluted earnings per common share | $0.42 | $0.52 | $1.01 | $0.95 |
| Net cash provided by operating activities | Not reported separately | Not reported separately | $1,484.3 | $1,414.9 |
| Net cash provided by (used in) investing activities | Not reported separately | Not reported separately | $(433.0) | $1,232.8 |
| Net cash used in financing activities | Not reported separately | Not reported separately | $(1,464.4) | $(927.2) |
For Q2, revenue rose 3.5% year over year, but common-stockholder income fell 10.8%; higher operating expenses and deferred policy acquisition cost (DPAC) amortization weighed on earnings. For the first half, revenue rose 3.5% and common-stockholder income increased 23.5%. The filing does not present a single consolidated operating-margin measure; reported segment operating earnings were $203.5 in Q2 2010 versus $200.5 in Q2 2009, and $459.1 versus $364.5 for the first half.
- Q2 total expenses increased to $2,075.8 from $1,959.9, including operating expenses of $683.8 versus $562.7.
- First-half net realized capital losses were $111.9, improved from $218.5 a year earlier. Other-than-temporary impairment losses on available-for-sale securities were $191.7 versus $347.5.
- First-half net investment income was $1,740.0, up from $1,688.6. Management cited inflation-linked returns in Chile and currency effects, partly offset by lower reinvestment yields and reduced investment-only assets.
Financial position, debt and liquidity
- At June 30, total assets were $136,596.5, total liabilities $127,524.8 and total stockholders’ equity $9,071.7. At December 31, 2009, those amounts were $137,759.4, $129,743.0 and $8,016.4, respectively. Equity attributable to PFG was $8,929.5, up from $7,893.5.
- Cash and cash equivalents were $1,827.3, down from $2,240.4 at year-end. The six-month cash decrease was $413.1. Operating cash flow increased, while investing cash flow turned negative as net investment purchases rose.
- Total debt was $1,698.9, comprising $126.5 short-term and $1,572.4 long-term debt, compared with $1,686.2 at year-end. Debt-to-equity excluding accumulated other comprehensive income was 18%, versus 19%; debt-to-capitalization on that basis was 15%, versus 16%.
- Management reported $1,049.1 of excess capital in holding companies and aggregate credit facilities of $705.6. The $579.0 commercial-paper program had $75.0 outstanding; its five-year backstop facility had no outstanding balance. Most other credit facilities were not committed.
- Management said liquidity was sufficient for current needs and reasonably foreseeable contingencies. Principal Life could distribute approximately $608.7 in 2010 under statutory limits; no dividend had been paid by June 30, although it transferred $300.0 of paid-in and contributed surplus to its parent.
Material changes and unusual items
- On April 30, PFG signed agreements concerning Brasilprev that give the joint venture exclusive access to Banco do Brasil’s bank network for pension-product distribution for 23 years and reduce PFG’s economic interest to 25%. The transaction generated an $80.1 pretax and $72.1 after-tax gain; management expects lower near-term earnings from the operation.
- Second-quarter results included a $66.5 provision for residential mortgage loan losses, primarily in the home-equity portfolio; $34.0 related to 2009. The first-half provision was $73.6.
- Fixed-maturity available-for-sale securities moved from a net unrealized loss position of $1.4588 billion at December 31 to a net unrealized gain position of $130.0 million at June 30. Management attributed most of the improvement to falling interest rates. Gross unrealized losses remained $2.0815 billion, including significant corporate and commercial mortgage-backed security losses.
- First-half results included a $7.8 after-tax charge related to healthcare reform’s elimination of the tax deduction for certain retiree prescription drug expenses after 2012.
- Adoption of revised variable-interest-entity consolidation rules on January 1 changed which entities were consolidated; the accounting change reduced retained earnings by $10.7 and increased accumulated other comprehensive income by $10.7. Management reported no material impact from the change to consolidated financial statements overall.
Outlook, risks and contingencies
The filing provides no formal companywide earnings guidance. Management estimated 2010 pre-tax pension expense of $110.4, down from $157.6 in 2009; approximately $27.6 was expected in each of the remaining two quarters. It also cautioned that interim results are not necessarily indicative of full-year results.
- Management highlighted exposure to capital-market and economic conditions, interest rates and credit spreads, equity-market declines, investment valuation and impairment judgments, policyholder behavior, ratings downgrades, foreign exchange, competition, and regulatory, tax and litigation outcomes.
- Portfolio risks include mortgage and structured securities. At June 30, problem and potential-problem fixed maturities totaled $579.9, or 1.24% of fixed maturities. Commercial mortgages classified as problem, potential problem or restructured were $382.2, or 3.91% of the portfolio, down from 6.20% at year-end. Residential mortgage nonperforming loans were $31.6; the related valuation allowance was $46.0.
- Management described pending ERISA, investment-fee and separate-account litigation and a health-claims class action filed July 1. It did not expect pending litigation or regulatory matters to materially affect business or financial position, but noted outcomes could materially affect an individual period.
- Standard & Poor’s downgraded Principal Life and Principal National financial-strength ratings from A+ to A in May and changed the outlook to stable. The filing also discusses the Dodd-Frank Act, signed July 21, 2010, and potential future capital, liquidity and derivatives requirements whose details were not yet known.
- Derivative counterparties could demand additional collateral if specified credit-rating triggers were breached. The filing estimated an additional $33.1 would be required under those triggers as of June 30. Net derivative counterparty exposure after collateral was $1,186.3 on a gross basis; management also reported a netted exposure of $92.4 after pledged collateral.
Important facts for investors to verify
- Whether the Brasilprev distribution arrangement and reduced ownership produce the anticipated longer-term business benefits despite lower near-term earnings.
- Subsequent credit performance, impairment recognition and valuation trends in CMBS, corporate bonds, home-equity loans and other structured investments.
- How lower equity markets, account values and interest rates affect DPAC amortization, annuity guarantees, fees and segment operating earnings.
- Liquidity and capital at the regulated insurance subsidiaries, including dividend restrictions, credit-facility availability and rating-agency actions.
- The financial and operating effects of healthcare reform and Dodd-Frank implementing rules, as well as developments in the disclosed litigation and tax audits.