Prudential Financial, Inc. — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; balance-sheet comparisons are with December 31, 2009. Unaudited. Prudential provides insurance, annuity, retirement, investment-management and related financial services in the U.S. and internationally. It reports Financial Services Businesses separately from its legacy Closed Block Business.
Key financial results
| Metric | Q1 2010 | Q1 2009 / prior date |
|---|---|---|
| Total revenue | $9.292 billion | $8.525 billion |
| Income before tax and equity in operating joint ventures | $1.016 billion | $3 million |
| Net income | $671 million | $3 million |
| Net income attributable to Prudential Financial, Inc. | $697 million | $14 million |
| Diluted EPS, Common Stock | $1.15 | $0.01 |
| Net cash from (used in) operating activities | $(51) million | $2.536 billion |
| Cash and cash equivalents, period-end | $9.626 billion | $13.164 billion at year-end 2009 |
| Total assets / total equity | $491.861 billion / $27.506 billion | $480.203 billion / $25.729 billion at year-end 2009 |
| Short- and long-term debt | $24.707 billion | $24.159 billion at year-end 2009 |
Net income attributable to the company exceeds consolidated net income because a $26 million loss was attributable to noncontrolling interests. The filing does not present a conventional consolidated profit margin as a key performance measure. Financial Services Businesses adjusted operating income before tax, a non-GAAP segment measure, was $952 million, compared with $565 million.
Net investment income was $2.874 billion versus $2.849 billion; realized investment gains were $389 million versus $138 million. The company recorded $1.249 billion of fixed-maturity impairment losses and a $995 million offset for impairments transferred to other comprehensive income. A total investment-income margin or consolidated liquidity ratio is not provided as a clear value.
Material changes and management commentary
- Reported earnings improved sharply from a near break-even prior-year quarter, reflecting improved markets and lower expenses, as well as differing variable-annuity valuation effects and Closed Block investment results. The comparison is affected by large, volatile market-related items and should not be read as a like-for-like rise in recurring earnings.
- Financial Services Businesses income from continuing operations was $512 million, versus a $20 million loss. Individual Annuities adjusted operating income rose to $260 million from $17 million; International Insurance rose to $484 million from $425 million. Group Insurance declined to $53 million from $93 million, mainly on adverse group-life claims and higher expenses.
- Closed Block income from continuing operations was $161 million, versus $19 million. Its pre-tax income rose to $259 million from $30 million, principally as realized investment results improved. The prior-year quarter included a $552 million benefit from a change in the cumulative-earnings policyholder dividend obligation; there was no such earnings benefit in Q1 2010. Current-period unrealized investment gains instead produced a $565 million dividend obligation for Closed Block policyholders.
- Sales and flows were mixed but improved in selected businesses: Individual Annuity gross sales were $4.9 billion versus $2.1 billion, and net sales $3.2 billion versus $665 million. Full Service Retirement net additions were $1.1 billion versus $6.3 billion, with prior-year additions boosted by large plan sales. International Insurance reported record-high sales; annualized new business premiums on a constant-currency basis were $396 million versus $337 million.
- Total assets under management were approximately $693 billion. Asset Management segment assets under management were $472.1 billion, versus $386.3 billion a year earlier.
- Available-for-sale fixed maturities had net unrealized gains of $4.091 billion, versus $1.656 billion at year-end 2009. Accumulated other comprehensive income improved to $620 million from a $443 million loss.
Liquidity, debt and capital
- Prudential Financial, the parent holding company, reported $3.459 billion of cash and short-term investments at March 31, down $371 million from year-end. Consolidated cash fell by $3.538 billion during the quarter; operating cash flow was negative, and investing activities used $3.670 billion.
- Consolidated debt was $24.707 billion, excluding asset-based financing and certain funding-agreement notes included in policyholder account balances. Total borrowings plus asset-based financing were $34.247 billion. The company issued $1.25 billion of parent medium-term notes in January and repaid the remaining $429 million of TALF borrowings.
- Management stated that available funding sources were sufficient for current and reasonably foreseeable liquidity needs. It also emphasized that the parent depends primarily on subsidiary distributions, which face regulatory restrictions and ratings-related considerations. Prudential Insurance had $2.0 billion of FHLBNY advances outstanding and $1.5 billion of FHLBNY funding agreements.
- Prudential Insurance’s reported year-end 2009 risk-based capital ratio was 577%; management estimated that domestic life subsidiaries remained above regulatory minimums at March 31. This is not a March 31 reported RBC calculation.
Outlook, risks and unusual items
- The filing provides no formal earnings guidance. Management cautions that interim results are not necessarily indicative of full-year results. Forward-looking statements are subject to economic and market conditions, interest rates, investment performance and defaults, insurance experience and reserve assumptions, ratings changes, regulation, litigation, and the ability of subsidiaries to distribute funds to the holding company.
- Variable-annuity guarantees remain sensitive to equity markets, interest rates, volatility, policyholder behavior and assumptions used in liability valuation. First-quarter results included material changes in embedded-derivative values and hedges; management notes that future market movements may cause further changes to reserves and deferred acquisition-cost amortization.
- Investment and valuation risk remains significant. Gross unrealized losses on fixed maturities were $5.4 billion at March 31, including losses concentrated in asset-backed securities and corporate securities. The company identified the sub-prime mortgage-backed market as inactive and used internal valuation inputs; it reported $5.262 billion fair value for the related Level 3 securities, including a $222 million valuation uplift versus external pricing estimates.
- Commercial real estate remains a risk. Asset Management’s interim loans had $1.6 billion principal outstanding, a weighted-average loan-to-value ratio of 113%, and $237 million of allowances or credit-related market-value losses. The filing also reports $47 million of foreclosed commercial real estate held for sale.
- A $94 million tax charge reduced deferred tax assets following 2010 health-care legislation affecting the tax treatment of Medicare Part D subsidies. The company says the subsidy provision becomes taxable beginning in 2013.
- Prudential signed an agreement to sell its Korean asset-management operations, subject to regulatory approval, with proceeds expected to approximate book value and closing expected in Q2 2010. Litigation and regulatory matters include claims with potentially large or indeterminate damages; management says outcomes are uncertain but does not expect the matters, after reserves and indemnification, to materially adversely affect financial position.
- Other exposures include $2.055 billion of commercial mortgage loan commitments; $1.888 billion of investee-debt guarantees; $10.742 billion of securities-lending indemnifications backed by $11.039 billion of collateral; and $948 million maximum exposure on written credit derivatives. Management reported no accrued liability for several of these guarantees and considered certain potential payments remote or unlikely.
Most important facts for investors to verify
- How much of the earnings rebound reflects sustainable segment operations versus market-sensitive marks, reserve and acquisition-cost adjustments, and the prior-year Closed Block dividend-obligation benefit.
- Whether operating cash flow, parent liquidity and subsidiary dividend capacity can support debt service, capital needs and policyholder obligations if markets weaken or ratings decline.
- The credit quality, impairment assumptions and valuation sensitivity of sub-prime, other asset-backed, commercial mortgage and Level 3 investments.
- The development of variable-annuity guarantee exposure, hedge effectiveness, policyholder behavior and related reserve assumptions.
- Progress and final economics of the Korean asset-management sale, commercial real-estate loan performance, and material litigation or guarantee developments.