Principal Financial Group, Inc. - 10-Q Summary
Business Context and Reporting Period
This is a Quarterly Report (Form 10-Q) for Principal Financial Group, Inc. (PFG) for the period ended June 30, 2008. PFG is a large accelerated filer providing financial products and services through five segments: U.S. Asset Accumulation, Global Asset Management, International Asset Management and Accumulation, Life and Health Insurance, and Corporate and Other. The company operates primarily in the United States with international operations in Brazil, Chile, China, Hong Kong, India, Malaysia, and Mexico.
Key Financial Metrics
| Metric (in millions) | Three Months Ended June 30, 2008 | Six Months Ended June 30, 2008 |
|---|---|---|
| Total Revenues | $2,658.2 | $5,158.9 |
| Net Income | $176.6 | $359.0 |
| Net Income Available to Common Stockholders | $168.3 | $342.5 |
| Diluted EPS | $0.64 | $1.31 |
| Net Investment Income | $991.0 | $1,951.3 |
| Net Realized/Unrealized Capital Gains (Losses) | $(111.5) | $(237.5) |
| Total Assets | $151,526.9 | $151,526.9 |
| Total Liabilities | $144,907.0 | $144,907.0 |
| Stockholders' Equity | $6,619.9 | $6,619.9 |
| Cash and Cash Equivalents | $1,524.5 | $1,524.5 |
| Short-term Debt | $215.1 | $215.1 |
| Long-term Debt | $1,384.0 | $1,384.0 |
Operating Cash Flow (Six Months): Net cash provided by operating activities was $1,073.1 million. Net cash used in investing activities was $2,326.7 million, primarily due to net purchases of available-for-sale securities. Net cash provided by financing activities was $1,433.7 million.
Material Changes vs. Prior Period
- Net Income Decline: Net income available to common stockholders decreased by $135.5 million (45%) for the three months and $218.4 million (39%) for the six months compared to the same periods in 2007.
- Capital Losses: The primary driver of the decline was a shift from net realized/unrealized capital gains in 2007 to significant losses in 2008. For the six months ended June 30, 2008, the company reported a net loss of $237.5 million compared to a gain of $93.0 million in 2007. This was driven by mark-to-market losses on derivatives not in hedge relationships and higher other-than-temporary impairments of fixed maturity and equity securities.
- Revenue Mix: Total revenues decreased $173.6 million (6%) for the quarter and $333.9 million (6%) for the six months. Premiums and other considerations declined due to fewer covered medical members in the Life and Health segment and lower annuity sales in the U.S. Asset Accumulation segment. However, Net Investment Income increased due to a larger asset base, despite a lower average annualized yield (5.9% for six months 2008 vs. 6.1% in 2007).
- Equity Impact: Accumulated other comprehensive income (loss) swung from a positive $420.2 million at year-end 2007 to a negative $(773.9) million at June 30, 2008, largely due to net unrealized losses on fixed maturities.
Guidance, Outlook, Risks, and Unusual Items
- Market Conditions: Management highlights the impact of the credit disruption in the market that began in late 2007 and continued into 2008, leading to reduced liquidity and wider credit spreads. This has resulted in increased unrealized losses, particularly in collateralized debt obligations (CDOs), asset-backed securities (ABS), and commercial mortgage-backed securities (CMBS).
- Impairments: The net realized loss relating to other-than-temporary credit impairments of fixed maturity securities was $74.4 million for the six months ended June 30, 2008. Gross unrealized losses on fixed maturity securities available-for-sale totaled $2,719.6 million as of June 30, 2008, compared to $1,168.2 million at year-end 2007.
- Segment Performance:
- U.S. Asset Accumulation: Operating earnings decreased due to lower fees from Principal Funds (driven by equity market declines) and reduced tax benefits from dividends received.
- Global Asset Management: Operating earnings decreased significantly due to inactivity in the commercial mortgage-backed securitization business and mark-to-market losses on mortgage loan inventory.
- International: Operating earnings increased, driven by growth in Chile and Mexico, partially offset by lower earnings from Brazil due to a tax rate increase.
- Life and Health: Operating earnings increased due to favorable claim development in health insurance and specialty benefits.
- Liquidity: The company believes cash flows from operations and access to capital markets are sufficient to meet liquidity requirements. Principal Life (the primary subsidiary) could pay approximately $686.5 million in dividends in 2008 without exceeding statutory limitations, though no dividends were paid to the parent as of June 30, 2008.
- Legal Proceedings: The company is involved in litigation regarding 401(k) revenue sharing fees and fiduciary duties. Management does not believe pending matters will have a material adverse effect, though outcomes are uncertain.
Investor Verification Checklist
- Investment Portfolio Quality: Verify the extent of unrealized losses in the fixed maturity portfolio, specifically in CDOs, CMBS, and sub-prime related ABS, and assess the likelihood of further other-than-temporary impairment charges.
- Derivative Exposure: Review the notional amounts and credit exposure of derivatives, particularly credit default swaps and interest rate swaps, and their impact on earnings volatility.
- Duration Gap: Confirm the asset-liability duration gap management, which was +0.12 as of June 30, 2008, and its sensitivity to interest rate changes.
- International Tax Impact: Assess the ongoing impact of the Brazilian tax rate increase on net investment income and foreign tax credits.
- Health Insurance Trends: Monitor the trend of covered medical members and claim costs in the Life and Health segment, which saw a decline in premiums but favorable claim development.
- Liquidity Constraints: Review the statutory dividend limitations on Principal Life and the company's ability to fund operations and debt service without relying on subsidiary dividends.