PFG

Principal Financial Group, Inc. - 10-Q Summary (Q3 2007)

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for Principal Financial Group, Inc. (PFG) for the period ended September 30, 2007. PFG is a large accelerated filer providing financial products and services through four primary segments: U.S. Asset Management and Accumulation, International Asset Management and Accumulation, Life and Health Insurance, and Corporate and Other. The company operates globally with significant presence in the U.S. and emerging markets including Brazil, Chile, and Mexico.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 16% year-over-year for the three months ended September 30, 2007 ($2,849.5M vs. $2,449.6M). This was driven by a 59% increase in fees and other revenues, largely due to the acquisition of WM Advisors, Inc. and higher assets under management.
• Net Income Decline (Q3): Net income decreased 7% to $240.5 million for the quarter, primarily due to an $89.3 million net realized/unrealized capital loss (compared to a $6.7 million loss in the prior year) driven by mark-to-market losses on derivatives and trading securities.
• Net Income Increase (YTD): For the nine months, net income increased 6% to $817.9 million, aided by strong operating earnings despite capital market volatility.
• Expense Increases: Operating expenses rose 29% in the quarter and 24% year-to-date, attributed to the WM Advisors acquisition and a comprehensive assumption study that unlocked previously deferred expenses.
• Investment Portfolio: Total investments grew to $62.9 billion. The company reported $917.7 million in gross unrealized losses on fixed maturity securities available-for-sale as of September 30, 2007, an increase from $299.9 million at year-end 2006, reflecting credit market disruptions.

Guidance, Outlook, and Risks

• Dividends: On October 29, 2007, the Board declared an annual common stock dividend of $0.90 per share (approx. $235.5 million) payable December 7, 2007. A preferred stock dividend of approx. $8.2 million was also declared.
• Share Repurchases: The company has active repurchase programs. As of September 30, 2007, $70.0 million remained available under the May 2007 program.
• Market Risks:
  • Interest Rate Risk: A 100 basis point increase in rates is estimated to decrease the net fair value of the portfolio by $70.9 million.
  • Credit Risk: The company noted increased unrealized losses in structured products (CDOs, ABS) due to credit disruption in Q3 2007. However, 96% of fixed maturity securities remain investment grade.
  • Derivatives: Significant exposure exists via interest rate swaps ($16.5B notional) and foreign currency swaps ($6.2B notional) used for hedging.
• Legal Contingencies: The company is involved in various litigation and regulatory inquiries, including class actions regarding 401(k) revenue sharing and broker compensation. Management does not believe these will have a material adverse effect, though outcomes are uncertain.

Investor Verification Checklist

• Unrealized Losses: Verify the composition of the $917.7 million in gross unrealized losses on fixed maturities and the company's intent to hold these securities to maturity.
• Derivative Exposure: Review the $172.4 million mark-to-market loss on derivatives in Q3 and the associated notional amounts ($27.5B total) to assess sensitivity to market volatility.
• Acquisition Integration: Assess the ongoing impact of the WM Advisors, Inc. acquisition on operating expenses and fee revenue growth.
• Liquidity Constraints: Confirm the ability of Principal Life Insurance Company to pay dividends to the parent company under Iowa statutory limitations (approx. $660M limit for 2007).
• Legal Reserves: Monitor developments in the Fairmount Park and other class action lawsuits regarding fiduciary duties and revenue sharing.