PRINCIPAL FINANCIAL GROUP INC quarterly report, Q2 FY2012

Principal Financial Group, Inc. — Q2 2012 Form 10-Q

Business context and period. Unaudited results cover the quarter and six months ended June 30, 2012, compared with the corresponding 2011 periods. Principal provides retirement and investment services, asset management, international financial products, and U.S. insurance. Its reported assets include substantial separate-account assets and matching liabilities; the company generally does not bear the investment risk on those separate accounts.

Financial performance and position

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Total revenue	$2,118.6 million	$2,296.4 million	$4,214.5 million	$4,518.3 million
Net income attributable to PFG	$181.4 million	$225.6 million	$391.1 million	$415.8 million
Net income available to common stockholders	$173.1 million	$217.3 million	$374.6 million	$399.3 million
Diluted EPS	$0.58	$0.67	$1.24	$1.23
Segment operating earnings, after tax	$216.3 million	$229.0 million	$429.3 million	$448.8 million

Q2 total revenue fell about 8% and common-stockholder income fell about 20% year over year; first-half revenue fell about 7% and common income about 6%. The filing does not present a consolidated operating margin.
Q2 segment operating earnings declined, with Retirement and Investor Services and Principal Global Investors weaker; Principal International was broadly flat in Q2 and higher for the half year. U.S. Insurance Solutions was slightly higher in Q2 and slightly lower for the half year.
At June 30, total assets were $152.1 billion, total liabilities $142.6 billion, and total stockholders’ equity $9.4 billion. Investments were $67.2 billion; cash and cash equivalents were $1.65 billion, down from $2.83 billion at year-end 2011.
Total debt was $1.84 billion, versus $1.67 billion at year-end; debt to equity excluding AOCI rose to 21% from 19%. Holding-company excess capital was $527.9 million. Short-term credit facilities totaled $914.7 million, with $262.9 million outstanding.
First-half operating cash flow was $1.50 billion, versus $1.79 billion in 2011. Investing activities used $826.8 million, compared with $793.9 million provided in 2011; financing activities used $1.86 billion, versus $2.29 billion.
The company paid $108.0 million in common dividends and repurchased $203.2 million of common stock during the first half. The quarterly dividend was $0.18 per share.

Material changes and notable items

The company attributed much of the year-over-year decline in common income to a $46 million after-tax gain from a partial sale of Catalyst Health Solutions in Q2 2011, with no comparable 2012 gain. Lower investment yields also reduced net investment income. Lower impairments helped offset some first-half declines.
Premiums and expenses both fell substantially in the exited group medical business, which remains in continuing-operations results because it did not qualify for discontinued-operations accounting. Its reported revenue was $4.0 million in Q2 2012 versus $180.8 million in Q2 2011.
Effective January 1, 2012, PFG retrospectively adopted revised deferred policy acquisition cost guidance and changed accounting for certain reinsurance contracts. The 2011 comparatives in this filing are adjusted; the changes materially altered certain prior-period line items, so comparisons with originally reported 2011 figures may differ.
In Q1 2012, a change in the amortization basis for certain individual life products shifted amounts among fees, benefits and operating expenses; management reported an immaterial $3.3 million after-tax net gain for the first half from the unlocking.
PFG acquired a 60% indirect interest in Brazilian asset manager Claritas in April 2012. It also deconsolidated hedge funds in Q2 after determining it was no longer their primary beneficiary; reported assets decreased $587.2 million and liabilities and noncontrolling interests decreased $586.1 million.
In July 2012, PFG’s Catalyst Health Solutions shares were acquired in a merger, producing an approximately $126 million after-tax gain expected to be recorded in Q3 2012. This is a subsequent event, not part of Q2 earnings.

Outlook, risks and contingencies

The filing gives no specific earnings or revenue guidance. Management said available cash, securities, operating cash flows and borrowing sources were expected to meet current liquidity needs and reasonably foreseeable contingencies.
Management highlighted sensitivity to interest rates, credit spreads, equity markets, investment valuations and impairments, policyholder behavior, foreign exchange, capital-market conditions, competition, regulation, taxes, litigation, catastrophe and reinsurer performance. Sustained low interest rates and market volatility could pressure investment returns, fees, earnings and asset values.
Gross unrealized losses on available-for-sale securities were $1.27 billion at June 30, down from $1.52 billion at year-end 2011. Management attributed improvement mainly to tighter credit spreads and said it did not intend, nor expect to be required, to sell the loss-position securities before recovering amortized cost. The filing notes that future impairment or sale could still reduce income.
Legal matters included litigation and regulatory inquiries; no losses were accrued for the discussed matters because management considered losses not probable and not reasonably estimable. Possible loss ranges could not be estimated. Guarantees related primarily to a former subsidiary had a maximum exposure of about $135 million, with material payment considered remote.
Principal Life’s S&P financial-strength rating was upgraded from A to A+ with a stable outlook in June 2012. The filing also notes that insurance-company dividends to the holding company are subject to Iowa statutory limits and regulatory approval.

Important facts for investors to verify

Review the adjusted 2011 comparatives and the effects of the DPAC and reinsurance accounting changes before interpreting year-over-year trends.
Separate ongoing segment performance from investment gains and losses, the 2011 Catalyst gain, and the exited group medical business.
Assess investment-credit exposure, especially commercial mortgage-backed securities, and monitor impairments, delinquencies and the mortgage-loan allowance.
Check liquidity and capital at the relevant legal entities, including the holding company’s excess capital, available facilities, debt levels and limits on subsidiary dividends.
Track the Q3 recognition of the approximately $126 million after-tax Catalyst merger gain and subsequent developments in litigation, tax matters and market risks.