Principal Financial Group, Inc. — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. The filing is unaudited.
Business context
Principal provides retirement and asset-accumulation products, asset management, international financial services, life insurance and specialty benefits. Its reportable segments are U.S. Asset Accumulation, Global Asset Management, International Asset Management and Accumulation, U.S. Insurance Solutions, and Corporate. Beginning in Q3, the company presented its group medical insurance business in Corporate after deciding to exit that business; prior-period segment results were restated.
Key financial results
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenues | $2,288.5 | $2,270.3 | $6,786.1 | $6,616.7 |
| Income before income taxes | $163.5 | $248.3 | $577.6 | $576.3 |
| Net income | $151.3 | $204.2 | $499.1 | $490.8 |
| Net income available to common stockholders | $142.2 | $184.7 | $467.0 | $447.8 |
| Diluted EPS | $0.44 | $0.57 | $1.45 | $1.54 |
| Operating cash flow | Not presented quarterly | $1,929.5 | $1,794.4 |
- Q3 revenue rose $18.2 million year over year, while common-stockholder income fell $42.5 million. The filing attributes the earnings decline primarily to the $43.6 million goodwill impairment and severance accruals associated with the group medical exit.
- For the first nine months, common-stockholder income increased $19.2 million. Higher fees and international and asset-management earnings were partly offset by the group medical exit-related costs and other items.
- Q3 operating expenses increased $108.5 million year over year to $751.5 million; nine-month operating expenses increased $217.1 million to $2,111.2 million. The filing cites the goodwill impairment and severance, as well as higher deferred acquisition cost amortization in U.S. Asset Accumulation.
- Net realized capital losses were $20.7 million in Q3 and $132.6 million for nine months, versus losses of $66.6 million and $285.1 million in the comparable 2009 periods. Net available-for-sale impairment losses were $49.6 million for Q3 and $183.3 million for nine months.
Financial position, debt and liquidity
- At September 30, 2010, total assets were $143.5 billion, total liabilities $133.4 billion, and total stockholders’ equity $10.0 billion. Assets included $65.7 billion of separate-account assets, matched by separate-account liabilities.
- Cash and cash equivalents were $2.27 billion, compared with $2.24 billion at December 31, 2009. Nine-month cash increased $28.4 million after $1.93 billion of operating cash flow, $305.9 million of investing cash inflow, and $2.21 billion of financing cash outflow.
- Total debt was $1.71 billion: $132.1 million short-term and $1.58 billion long-term. Debt to capitalization, excluding accumulated other comprehensive income, was 15%, versus 16% at year-end 2009. Management reported $1.07 billion of excess capital in holding companies.
- Management said liquidity sources, including operations, borrowing facilities and potential capital-market access, were sufficient for current needs and reasonably foreseeable contingencies. Of institutional guaranteed investment contracts and funding agreements, approximately $13.0 billion, or 98%, could not be redeemed before maturity.
- Principal Life could distribute approximately $608.7 million in 2010 under stated statutory limits; it had made no dividend distribution as of September 30, though it distributed $300 million of paid-in and contributed surplus to its parent in June.
Material changes, outlook and notable items
- Group medical exit: The company agreed with United Healthcare Services to renew customer coverage during a transition expected to take 36 months. The business remained in continuing operations and generated $344.1 million of Q3 revenue and $1,050.2 million for nine months. The company recorded a $43.6 million goodwill impairment; it anticipated employee-benefit curtailment gains as affected employees are terminated, but gave no amount.
- Brasilprev: Agreements with Banco do Brasil reduced Principal’s economic interest to 25% and gave the joint venture exclusive distribution rights through Banco’s network for 23 years. The transaction generated a $72.1 million after-tax gain in Q2; management expected lower near-term earnings from the investment.
- Capital markets and investments: Net unrealized gains on available-for-sale securities and derivatives improved to $697.3 million from a $640.5 million net unrealized loss at year-end 2009, largely reflecting market changes, including lower interest rates. Management cautioned that future values depend on rates, credit spreads and market liquidity. Gross unrealized losses on available-for-sale fixed maturities were still $1.62 billion; commercial mortgage-backed securities accounted for $873.6 million.
- Credit exposures: The filing reports $399.3 million of problem, potential-problem and restructured commercial mortgages, or 4.18% of that portfolio, down from $627.8 million, or 6.20%, at year-end. Residential mortgage loan allowance rose to $45.2 million from $28.7 million; the filing cites continued stress in home-equity lending and an $82.8 million nine-month provision.
- Guidance: No general earnings or revenue guidance was provided. Management estimated 2010 pre-tax pension expense of $110.4 million, excluding any group-medical-exit curtailment gain, versus $157.6 million in 2009. It reported $33 million contributed to pension plans through September and said total 2010 contributions could be $40–$50 million.
- Dividends: On November 1, the board declared an annual common dividend of $0.55 per share, approximately $176.2 million in total, payable December 3 to holders of record November 19.
- Other risks and contingencies: Management identified market, interest-rate, credit, equity, foreign-currency, insurance-reserving, rating, regulatory and litigation risks. The filing discusses pending ERISA and investment-fund litigation; management did not expect pending matters to materially affect the business or financial position, but noted outcomes could affect income in a period. Guarantees had maximum exposure of approximately $221 million, with accrued liability described as insignificant and material payment considered remote.
- Regulatory and accounting changes: The Dodd-Frank Act’s implementing rules were not yet known; the company anticipated possible Federal Reserve oversight, additional capital and liquidity requirements, and expanded derivatives regulation and collateral demands. New VIE consolidation rules and adoption of the fair-value option for certain securities changed presentation and contributed to a $25.4 million retained-earnings adjustment for the latter adoption.
Important facts for investors to verify
- How much of Q3 expense growth and reduced earnings relates to group-medical exit costs, and what transition, severance and curtailment costs or gains remain.
- Whether the improvement in investment impairments and unrealized values persists, particularly for CMBS, residential mortgage and other structured-credit holdings.
- Progress in reducing the primary duration-managed portfolio gap, which was negative 0.41 against a stated target range of plus or minus 0.25; management said it was evaluating options.
- Whether residential mortgage credit losses, including home-equity losses, require further provisions, and whether problem commercial mortgage exposures continue to decline.
- Effects of the 25% Brasilprev interest and foreign-exchange movements on recurring international earnings, distinguishing them from the one-time transaction gain.
- Potential effects of Dodd-Frank implementation, healthcare reform, rating changes, litigation and insurance-dividend restrictions on capital, liquidity and distributions.