Business Context and Reporting Period
Company: Principal Financial Group, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2003
Business Overview: Principal provides financial products and services through five segments: U.S. Asset Management and Accumulation, International Asset Management and Accumulation, Life and Health Insurance, Mortgage Banking, and Corporate and Other. The company operates primarily in the U.S. with international subsidiaries in Latin America, Asia, and the Middle East.
Key Financial Metrics
| Metric (in millions) | Three Months Ended June 30, 2003 |
Six Months Ended June 30, 2003 |
Six Months Ended June 30, 2002 |
|---|---|---|---|
| Total Revenues | $2,412.4 | $4,709.2 | $4,563.3 |
| Net Income | $202.2 | $357.9 | $85.3 |
| Income from Continuing Ops | $202.6 | $359.0 | $360.1 |
| Diluted EPS | $0.62 | $1.09 | $0.24 |
| Total Assets | $98,621.7 | $98,621.7 | $89,861.3 (Dec 31, 2002) |
| Total Liabilities | $91,082.7 | $91,082.7 | $83,204.1 (Dec 31, 2002) |
| Stockholders' Equity | $7,539.0 | $7,539.0 | $6,657.2 (Dec 31, 2002) |
| Cash & Equivalents | $1,525.2 | $1,525.2 | $1,038.6 (Dec 31, 2002) |
| Short-term Debt | $665.4 | $665.4 | $564.8 (Dec 31, 2002) |
| Long-term Debt | $1,360.2 | $1,360.2 | $1,332.5 (Dec 31, 2002) |
| Operating Cash Flow (6mo) | N/A | $2,824.4 | $1,937.7 |
Material Changes vs. Prior Period
- Net Income Surge: Net income for the six months ended June 30, 2003, increased to $357.9 million from $85.3 million in the prior year. This significant increase is largely attributable to the absence of a $280.9 million cumulative effect of accounting change (SFAS 142) recorded in 2002 and improved operating performance.
- Revenue Growth: Total revenues increased 3% year-over-year for the six-month period ($4,709.2 million vs. $4,563.3 million). "Fees and other revenues" grew 52% to $1,321.0 million, driven primarily by a 100% increase in Mortgage Banking segment revenues due to higher loan production volumes.
- Expense Increases: Operating expenses rose 40% to $1,664.9 million for the six months ended June 30, 2003. This was primarily due to a $363.5 million increase in the Mortgage Banking segment (servicing portfolio growth and impairment charges) and higher compensation costs in the U.S. Asset Management segment.
- Capital Gains/Losses: The company reported net realized/unrealized capital losses of $87.6 million for the six months ended June 30, 2003, compared to net gains of $6.6 million in the prior year. This shift was due to the absence of a $183.0 million capital gain from the sale of Coventry Health Care stock in 2002.
- Balance Sheet Expansion: Total assets increased by $8.8 billion to $98.6 billion, driven by growth in fixed maturities ($37.4 billion) and mortgage loans ($11.7 billion).
Guidance, Outlook, Risks, and Unusual Items
- Accounting Changes (FIN 46): The company anticipates consolidating Principal Residential Mortgage Capital Resources, LLC (PRMCR) by September 30, 2003, under new FASB rules. This is expected to add approximately $3.7 billion in assets and liabilities to the balance sheet.
- Stock Repurchases: In May 2003, the Board authorized a $300 million stock repurchase program. The company completed the full $300 million repurchase (10.3 million shares) during the first six months of 2003.
- Dividend Restrictions: Dividends from Principal Life Insurance Company are limited by Iowa law. Based on 2002 statutory results, the company could pay approximately $746.6 million in dividends in 2003 without exceeding statutory limits. A $200 million dividend accrual was reversed as of June 30, 2003.
- Contingencies:
- BT Financial Group Indemnification: The company indemnified Westpac for potential late filings in New Zealand up to A$250 million (~$170 million USD). Management believes the likelihood of material payment is remote but acknowledges potential impact on net income in a specific quarter.
- Legal Proceedings: A lawsuit regarding the company's demutualization was dismissed by the U.S. Supreme Court in June 2003. Management does not expect pending litigation to have a material adverse effect.
- Market Risks: The company faces interest rate risk, equity risk, and foreign currency risk. A 100 basis point increase in interest rates is estimated to increase the net fair value of the primary duration-managed portfolio by $27.9 million. A 10% decline in equity securities would result in a $41.0 million unrealized loss.
- Impairment Policy: In Q2 2003, the company established a policy to evaluate permanent impairment of mortgage servicing rights, recording a $500.2 million write-down that reduced the gross carrying value but had no immediate impact on net income.
Investor Verification Checklist
- BT Financial Group Proceeds: Verify the status of the remaining contingent proceeds (up to A$150 million) from the sale of BT Financial Group to Westpac, expected in 2004.
- FIN 46 Consolidation Impact: Monitor the September 2003 consolidation of PRMCR and its effect on leverage ratios and reported debt levels.
- Mortgage Servicing Rights: Review future quarters for the impact of the new permanent impairment policy on amortization expense and net income.
- Dividend Policy: Confirm the timing and amount of future dividends from Principal Life, given the reversal of the $200 million accrual and statutory limitations.
- Interest Rate Sensitivity: Assess the company's hedging effectiveness given the low interest rate environment and the duration gap in the primary portfolio.