Business context and reporting period
Prudential Financial, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2009. The company provides insurance, retirement, investment management and related financial services in the U.S. and internationally. Its reporting separates the Financial Services Businesses from the legacy Closed Block Business, though these are not separate legal entities. Dollar amounts below are in millions unless noted.
Financial results and liquidity
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Total revenue | $6,906 | $7,703 | $15,465 | $15,261 |
| Realized investment losses, net | $(2,275) | $(898) | $(2,130) | $(1,810) |
| Income from continuing operations | $159 | $592 | $161 | $674 |
| Net income attributable to Prudential Financial | $163 | $581 | $177 | $641 |
| Diluted continuing-operations EPS, Common Stock | $1.20 | $1.33 | $1.23 | $1.49 |
- Revenue in Q2 declined about 10%; first-half revenue edged up about 1%. Net income attributable to the company fell about 72% in Q2 and 72% for the first half.
- Financial Services Businesses adjusted operating income, a non-GAAP segment measure, was $1,126 in Q2 2009 versus $1,127 in Q2 2008, and $1,703 for the first half versus $2,058. The filing cautions that this measure is not a substitute for GAAP results.
- Cash from operations was $3,759 for the first half; investing activities provided $191 and financing activities used $5,434. Cash and equivalents declined $1,537 to $13,491.
- At June 30, total assets were $444,716 and total equity was $18,675, versus $445,011 and $13,786 at December 31, 2008. Prudential Financial parent cash and short-term investments were $4,735.
- Consolidated short- and long-term debt totaled $24,624, down from $30,825 at year-end; short-term debt fell to $3,643 from $10,535. This includes $1,167 of TALF-related long-term financing. Separate-account assets and liabilities were each $151,266 and should not be treated as general-account liquidity.
- Fixed-maturity available-for-sale investments had fair value of $158,913 and amortized cost of $166,075. Cash, cash equivalents and short-term investments on the consolidated balance sheet totaled $20,628.
Material changes, outlook, risks and unusual items
- Large investment losses weighed on GAAP results. First-half fixed-maturity impairments totaled $3,167 before the portion recorded in other comprehensive income; $2,063 of that amount was recognized in OCI under newly adopted impairment guidance. Other realized investment losses and derivative marks also contributed.
- The company concluded the sub-prime mortgage-backed securities market was inactive and used internal discounted-cash-flow valuations. It valued certain such securities $693 above third-party pricing indications; the adjusted value was $5,362. Level 3 assets totaled $24,201, including separate-account assets whose market risk is generally borne by customers.
- Individual Annuities adjusted operating income improved to $432 in Q2 from $154, aided by market recovery and reserve/DAC effects; results also included substantial volatility from embedded guarantees and hedges. The Retirement segment earned $99 versus $141, while Asset Management earned $33 versus $190, reflecting lower fees and weaker proprietary investment and commercial mortgage results.
- The Closed Block Business reported a Q2 continuing-operations loss of $375 versus income of $15 a year earlier; first-half loss was $356 versus income of $7. Investment losses and lower investment income were partly offset by lower policyholder dividends. Its cumulative-earnings dividend obligation was zero at June 30 after actual cumulative earnings fell $622 below expected levels.
- In June, Prudential issued 36.9 million common shares at $39 per share, netting $1,391, and issued $1,000 of medium-term notes. It repurchased $1,819 of convertible notes at par as required by holders; $87 remained outstanding at quarter-end. Management said the capital actions strengthened liquidity but constrained investment flexibility.
- The company declined participation in the U.S. Treasury TARP Capital Purchase Program after preliminary approval and used TALF financing for eligible asset-backed securities. Prudential Insurance also had $3,500 of FHLBNY borrowings and funding agreements outstanding, supported by pledged assets.
- Management estimated proceeds of approximately $5 billion from its planned put of the Wachovia Securities interest to Wells Fargo, expected around January 1, 2010, and estimated a $2.7 billion pre-tax gain (about $1.8 billion after tax). These figures were estimates, not final terms; Wells Fargo indicated payment would include an unspecified mix of cash and stock. Prudential would bear market risk on any stock received.
- Q2 income benefited from a $147 reduction in unrecognized-tax-benefit and interest liabilities. Management expected a further approximately $165 reduction in Q3 following expiration of a tax statute of limitations. The filing provides no formal earnings guidance and warns results remain sensitive to markets, rates, credit losses, policyholder behavior, ratings and regulation.
- Contingencies include $2,022 of commercial mortgage loan commitments, $9,879 of other commitments, guarantees and indemnities, and ongoing litigation and regulatory matters. The company stated outcomes are uncertain but management did not believe pending matters, after reserves and indemnification, were likely to materially harm financial position.
Important facts for investors to verify
- Review the investment impairment details, sub-prime and commercial real-estate exposures, and the valuation assumptions and sensitivity of Level 3 assets and variable-annuity guarantees.
- Track ratings, collateral requirements, FHLBNY capacity and covenants, commercial-paper access, and parent-company liquidity and subsidiary dividend capacity.
- Confirm final proceeds, consideration mix, timing and gain from the Wells Fargo put, as well as any market risk from shares received.
- Assess whether segment operating trends, annuity sales and surrenders, asset-management fees, and Closed Block results persist beyond this volatile period.
- Monitor legal, regulatory and tax developments, including the listed class actions, contingent commitments, and future changes to the dividends-received deduction.