PRUDENTIAL FINANCIAL INC quarterly report, Q3 FY2017

Prudential Financial, Inc. — Q3 2017 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2017; balance-sheet comparisons are with December 31, 2016. Unaudited results are prepared under U.S. GAAP. Prudential provides insurance, annuity, retirement, investment-management and related financial services in the U.S. and internationally.

Key financial results

MetricQ3 2017Q3 2016Nine months 2017Nine months 2016
Revenue$16.313B$16.961B$43.424B$45.729B
Income before tax and equity earnings of operating joint ventures$3.021B$2.315B$5.371B$5.388B
Net income attributable to Prudential Financial$2.238B$1.827B$4.098B$4.084B
Diluted EPS$5.09$4.07$9.29$9.02
Net investment income$4.076B$4.073B$12.226B$11.532B
Operating cash flowNot separately provided for the quarter$8.761B$17.074B

Q3 revenue declined about 4% year over year while attributable net income rose about 23%. For the first nine months, revenue fell about 5% and attributable net income was nearly flat. Nine-month operating cash flow fell substantially; investing activities used $8.189B and financing activities used $303M. Cash and cash equivalents ended the period at $14.541B, up from $14.127B at year-end 2016. The filing does not provide a conventional consolidated profit-margin measure.

Financial position, debt and capital

  • Total assets were $821.131B, versus $783.962B at year-end 2016; total equity was $50.565B, versus $46.088B. Separate-account assets and matching liabilities were $301.110B.
  • Total consolidated borrowings were $19.511B, up from $19.174B. Short-term debt was $2.358B and long-term debt was $17.153B. The company reported compliance with debt covenants.
  • Prudential issued $750M of 4.50% fixed-to-floating junior subordinated notes in September and redeemed $500M of captive surplus notes. No amounts were drawn on committed credit facilities at September 30; the amended $4.0B five-year facility runs to July 2022.
  • Management’s capital measure was $46.161B, including equity excluding AOCI and capital debt. Parent-company highly liquid assets were $5.433B; excluding net intercompany liquidity-account borrowings, they were $4.390B. Management said available cash sources were sufficient under reasonably foreseeable stress scenarios.
  • Common dividends declared were $0.75 per share in Q3 and $2.25 per share for the nine months. The company repurchased $937M of shares under its $1.25B 2017 authorization through September.

Material changes and segment performance

  • Q3 earnings included significant market-related items. Management attributed the year-over-year increase in attributable net income to a $373M favorable variance from variable-annuity embedded derivatives and hedges and a $450M favorable variance primarily from higher segment operating results. These benefits were partly offset by lower net realized gains and unfavorable DAC, cost and reserve adjustments.
  • Nine-month results were affected by large offsetting items. Management cited $2.402B of favorable variance, primarily from business-segment operating results and improved Closed Block results, and $1.987B of favorable variance from changes to interest-rate risk management. These were offset by a $3.292B unfavorable variable-annuity embedded-derivative and hedge variance and $1.545B lower net realized gains, excluding the specified variable-annuity hedging impact.
  • Adjusted operating income before tax, a non-GAAP segment measure, was $1.784B in Q3 versus $1.558B; nine-month adjusted operating income was $4.672B versus $3.940B. Q3 increases included Asset Management, Individual Life and International Insurance; Individual Annuities was slightly lower. Nine-month Individual Life reported an adjusted operating loss of $289M versus a $59M loss, reflecting assumption updates and other refinements.
  • Individual Life recorded a $237M second-quarter charge from a change in estimate and accounting method for certain universal-life reinsurance cash flows. Its 2017 annual review produced a $653M net charge, principally related to modeling and systems refinements, reinsurance accounting and unfavorable lapse assumptions.
  • Individual Annuities’ nine-month account values rose with market appreciation, but net flows were negative $4.194B versus negative $706M in the prior-year period; sales were lower and surrenders and withdrawals higher. Management linked lower sales partly to the evolving DOL fiduciary rules.
  • Asset Management benefited from higher asset-management fees, market appreciation and strategic-investment results. Assets under management were $1.134T, up from $1.040T at year-end 2016.
  • Prudential announced a new U.S. organizational structure for Q4 2017 reporting, retaining its segments and segment-profit measure while realigning them into divisions.

Outlook, risks and contingencies

  • Low interest rates: Management expected portfolio yields to continue declining as assets mature and are reinvested at lower rates. It estimated scheduled payments and prepayments at about 6.1% of specified U.S. fixed-maturity and commercial-mortgage portfolios through 2018. Under a stated hypothetical U.S. rate scenario, the estimated pre-tax adjusted-operating-income impact was unfavorable by about $1M in 2017 and $46M in 2018 for the specified contracts. A separate hypothetical 25-basis-point reduction in Japanese and Korean new-money yields implied a $10M–$15M unfavorable 2017 impact. These are scenarios, not guidance.
  • The company cited market, interest-rate, equity, credit, currency, mortality, morbidity, lapse and policyholder-behavior risks; effectiveness of hedging; investment losses and defaults; and regulatory, tax and litigation uncertainty. International results and capital are also exposed to foreign exchange movements.
  • Regulatory developments included partial application of DOL fiduciary rules, a proposed delay to further provisions, and uncertainty around potential changes to Dodd-Frank and U.S. tax law. Management said impacts could not yet be predicted. Prudential was identified as a Designated Financial Company and a global systemically important insurer; tighter regulatory capital, liquidity and other requirements may affect distributions and operations.
  • The company reported a less-than-$250M aggregate range of reasonably possible litigation and regulatory losses in excess of established accruals for matters where an estimate could be made. This is not an expected-loss estimate or a maximum exposure. A securities-lending remediation plan was substantially implemented; discussions with SEC staff regarding a possible settlement and financial remedies were ongoing, with outcome uncertain.
  • Other disclosed exposures include $5.170B of securities-lending indemnifications, supported by collateral valued at $5.286B, with no accrued liability; and $1.521B maximum exposure under mortgage-servicing indemnifications, including $459M of first-loss exposure and a $13M accrued liability. Management considered possible payments under securities-lending indemnities remote.

Most important facts for investors to verify

  • How much of reported earnings and the Q3 increase is recurring operating performance versus realized investment gains and variable-annuity derivative and hedge movements?
  • Whether the Individual Life reinsurance-method change, annual assumption reviews and reserve refinements have further effects on earnings, reserves or statutory capital.
  • Whether negative Individual Annuities flows persist, and how sales, surrenders and the DOL fiduciary-rule changes affect future fees and account values.
  • How reinvestment yields, Japanese and U.S. interest rates, currency movements and hedge collateral needs affect spreads, earnings, liquidity and insurance-subsidiary capital.
  • Developments in the securities-lending regulatory review, other litigation and possible U.S. tax or regulatory changes, including effects on capital and shareholder distributions.