Principal Financial Group, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited consolidated financial statements. Principal provides retirement and investment products, asset management, international financial services, and U.S. life and specialty benefits insurance.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $2,342.0 million | $2,233.6 million | $4,561.8 million | $4,497.6 million |
| Income before taxes | $372.3 million | $157.8 million | $655.8 million | $414.1 million |
| Net income attributable to PFG | $266.3 million | $142.3 million | $470.8 million | $341.3 million |
| Net income available to common stockholders | $258.0 million | $134.0 million | $454.3 million | $324.8 million |
| Diluted EPS | $0.80 | $0.42 | $1.40 | $1.01 |
| Operating earnings, after tax | $237.3 million | $190.4 million | $469.1 million | $411.8 million |
Reported revenue increased 4.9% in Q2 and 1.4% for the first half; common earnings rose 92.5% and 39.9%, respectively. Segment operating earnings increased about 25% in Q2 and 14% year to date. A consolidated profit-margin measure is not presented; reported results include material investment gains, actuarial model changes, and the exiting group medical business.
- Revenue mix: First-half premiums and other considerations were $1,549.0 million, down from $1,747.1 million; fees and other revenues were $1,299.4 million, up from $1,122.4 million; net investment income was $1,733.7 million, modestly below $1,740.0 million.
- Cash flow: First-half operating cash flow was $1,785.5 million (2010: $1,484.3 million); investing activities provided $793.9 million (2010: used $433.0 million); financing activities used $2,287.2 million (2010: used $1,464.4 million). Cash and equivalents ended at $2,169.6 million.
- Balance sheet at June 30: Assets were $149.3 billion; total stockholders’ equity was $10.7 billion. Separate-account assets and liabilities were each $73.1 billion. Invested assets totaled $66.0 billion.
- Debt and liquidity: Short- and long-term debt totaled $1.69 billion, little changed from year-end. Debt to capitalization was 15% excluding accumulated other comprehensive income. The company reported $1.06 billion of excess holding-company capital and $745 million of short-term credit facilities, with $107.9 million borrowed. The $579 million commercial-paper program was fully backstopped; its backstop facility matures in June 2012.
- Investment and credit measures: Available-for-sale fixed maturities were $48.9 billion. Gross unrealized losses on these securities declined to $1.04 billion from $1.45 billion at year-end, which management attributed mainly to tighter credit spreads and lower interest rates. Mortgage loans carried at $10.8 billion; their valuation allowance was $114.3 million.
Material changes and drivers
- Higher account values and equity-market improvement supported fees and earnings in Retirement and Investor Services; its first-half operating earnings were $320.6 million versus $286.0 million.
- Principal Global Investors’ first-half operating earnings rose to $37.4 million from $24.3 million, supported by higher average assets under management and real-estate transaction fees. AUM ended at $226.0 billion; first-half net cash flow was negative $3.2 billion.
- Principal International’s first-half operating earnings fell to $66.0 million from $72.9 million. Growth in AUM and currency translation were offset by lower Brazil joint-venture earnings and other expenses; ending AUM was $53.0 billion.
- U.S. Insurance Solutions’ first-half operating earnings increased to $109.0 million from $94.1 million, including growth in specialty benefits and universal-life business. Q2 included individual-life model and assumption changes that generated a $3.9 million after-tax net loss, despite substantial offsetting movements across fees, benefits, and operating expenses.
- Reported earnings benefited from the sale of part of the Catalyst Health Solutions investment: approximately $46 million after tax, excluded from operating earnings. Q2 operating earnings also reflected a $19.5 million after-tax Foundation contribution and $18.8 million of after-tax gains associated with the exited group medical business.
- The group medical insurance exit reduced reported premiums and claims versus 2010; its results remained in GAAP continuing operations and were excluded from segment operating earnings, apart from corporate overhead.
- The company repurchased $236.2 million of treasury stock in the first half after reinstating its buyback program in May. Outstanding shares declined from 320.4 million at year-end to 313.7 million at June 30.
Outlook, risks, and contingencies
- Guidance: The filing provides no consolidated earnings or revenue guidance. Management states interim results are not necessarily indicative of full-year results.
- Acquisitions: Finisterre Capital’s acquisition closed July 1, 2011; initial consideration was $84.6 million, with up to $30 million of contingent consideration. The proposed $198 million acquisition of HSBC AFORE was subject to regulatory approval and expected to close in August. A proposed majority stake in Origin Asset Management, with an initial payment of approximately $66 million, was expected to close in Q4 2011.
- Market and business risks: Management highlights capital-market and economic conditions, equity-market declines that could reduce AUM and fee income, interest-rate and credit-spread movements, investment impairments and valuation uncertainty, policyholder behavior, competition, ratings downgrades, foreign exchange, and litigation and regulatory outcomes. A hypothetical 10% equity-market decline followed by a 2% quarterly recovery would reduce annual operating earnings by an estimated 4%–6%.
- Interest-rate sensitivity: A hypothetical immediate 100-basis-point rate increase was estimated to raise the net fair value of the specified portfolio by approximately $707 million. Management cautions that this point-in-time scenario is not a forecast.
- Credit and real estate: Commercial mortgage loans were concentrated in office, retail, and industrial properties; 3.76% were classified as problem, potential problem, or restructured. Residential mortgage losses remained exposed to unemployment and weak collateral values. Management reported substantial long-dated unrealized losses in some CMBS and corporate securities but said it did not intend, and was not more likely than not required, to sell the affected securities before cost recovery.
- Derivatives and ratings: Net derivative counterparty exposure was $872.6 million after collateral received, before further counterparty netting described by management. Certain derivatives allow counterparties to demand additional collateral if debt ratings fall below investment grade; an additional $53.8 million would have been required if those provisions were triggered at June 30. Fitch changed the outlook on Principal Life and Principal National Life to stable from negative in June.
- Legal and other contingencies: The company reported ongoing ERISA and investment-fee litigation; losses were not accrued because management considered them not probable and not reasonably estimable. Management said these matters were not expected to materially affect the business or financial position, while acknowledging outcomes are uncertain. Guarantees had maximum exposure of approximately $220 million; material payments were considered remote. The IRS completed examinations for 2004–2008 and proposed assessments; tax-review outcomes remain uncertain.
Important facts for investors to verify
- How much of the earnings increase reflects recurring segment performance versus the Catalyst gain, actuarial unlocking, and other unusual items.
- Trends in retirement deposits and withdrawals, AUM and net flows, and the effects of continued equity-market or interest-rate volatility.
- Credit quality, impairment assumptions, and exposure to CMBS, commercial real estate, and residential mortgage losses.
- Progress, costs, and regulatory approvals for the announced acquisitions, and the continuing financial effects of the group medical exit.
- Holding-company liquidity, debt and credit ratings, share repurchases, and the outcome of litigation and tax assessments.