PRINCIPAL FINANCIAL GROUP INC quarterly report, Q2 FY2016

Principal Financial Group, Inc. — Q2 2016 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2016; unaudited. The company provides retirement and income products, asset management, international savings and insurance solutions.

Financial performance and position

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Total revenue	$3,025.7 million	$3,259.2 million	$6,062.3 million	$5,916.5 million
Income before taxes	$399.9 million	$294.5 million	$839.7 million	$752.6 million
Net income	$327.0 million	$264.9 million	$696.2 million	$694.0 million
Net income attributable to PFG	$322.3 million	$257.6 million	$690.3 million	$680.0 million
Diluted earnings per common share	$1.10	$0.81	$2.35	$2.20
Common dividends declared per share	$0.39	$0.38	$0.77	$0.74

Operating cash flow was $2,125.6 million for the first half, essentially unchanged from $2,117.4 million a year earlier. Investing activities used $3,674.0 million, versus $937.1 million; financing activities provided $1,239.0 million, versus $779.8 million used in 2015. Cash and equivalents ended at $2,255.4 million, down from $2,564.8 million at year-end.
At June 30, total assets were $223.1 billion and total liabilities $212.2 billion. Stockholders’ equity was $10.6 billion, including $10.5 billion attributable to PFG. These totals include $134.7 billion of separate account assets matched by equal liabilities; clients direct those investments and bear their investment risk.
Total debt was $3,296.1 million, comprising $25.9 million short-term and $3,270.2 million long-term debt. Debt-to-equity excluding accumulated other comprehensive income was 31%, down from 34% at year-end 2015. The company reported $956 million of cash and liquid assets at holding companies and other subsidiaries available for corporate purposes.
Net investment income was $799.2 million in Q2 and $1,560.9 million in the first half. Annualized yield on invested assets, net of investment expenses, was 4.3% in both periods, versus 4.7% and 4.5%, respectively, in 2015.
Management’s segment pre-tax operating earnings were $431.2 million in Q2 versus $429.5 million, and $787.5 million for the first half versus $850.4 million. This non-GAAP operating measure excludes or adjusts certain realized gains and other items; the filing does not present a single consolidated operating margin.

Changes versus comparable periods

Q2 revenue fell $233.5 million (about 7%), chiefly as premiums declined $406.4 million, primarily from lower single-premium group and individual annuity sales. Lower benefits and claims, and the swing from realized investment losses in 2015 to gains in 2016, more than offset the revenue decline in reported earnings.
Q2 net realized capital gains were $33.7 million, compared with losses of $114.6 million. For the first half, gains were $170.3 million versus losses of $48.4 million. The swing reflected derivative and hedge results, noncredit fixed-maturity gains, and other items; results remain sensitive to market movements and transactions.
First-half revenue increased $145.8 million, while net income was nearly flat. Common-stockholder income rose to $690.3 million from $655.3 million, partly because 2015 included preferred dividends and an $8.2 million preferred-share redemption adjustment. First-half 2015 also included a $105.2 million tax benefit from a Chilean legal-entity merger.
Segment trends were mixed: first-half Retirement and Income Solutions pre-tax operating earnings fell to $376.1 million from $419.8 million, mainly on lower fee revenue linked to lower average equity markets. Principal Global Investors rose to $197.2 million from $191.1 million, helped by real-estate performance fees. U.S. Insurance Solutions increased to $184.1 million from $170.0 million. Principal International declined to $137.9 million from $153.0 million, affected by currency weakness and unfavorable changes to a Chilean regulatory investment.
Assets under management at Principal Global Investors rose to $382.8 billion from $359.6 billion a year earlier; Principal International AUM increased to $130.9 billion from $117.5 billion, including favorable exchange-rate effects.
Other comprehensive income was $878.3 million for the first half, versus a $371.8 million loss a year earlier, primarily reflecting unrealized investment gains and foreign-currency translation. Accumulated other comprehensive loss narrowed to $19.3 million from $882.5 million at year-end.

Outlook, risks and unusual items

No specific earnings or revenue guidance is provided. Management said operating results for the first half should not be taken as necessarily indicative of full-year results. It expects the new Department of Labor fiduciary rules to have no significant effect on financial condition or results, while continuing to assess implementation impacts.
Management said liquidity resources and committed credit facilities are adequate for current and reasonably foreseeable needs. About 99% of institutional GICs and funding agreements, totaling approximately $9.7 billion, could not be redeemed before maturity. Principal Life’s 2016 dividend capacity under Iowa statutory limits was approximately $937 million; it had paid $525 million to its parent by June 30.
Market exposures remain important. A hypothetical immediate 100-basis-point rise in rates implied a $2.693 billion net fair-value loss, compared with $2.483 billion at year-end; this is a sensitivity scenario, not a forecast. A 25-basis-point rate decline was estimated to reduce domestic investment margins by an immaterial amount over the following 12 months and $6–8 million pre-tax over the subsequent 12 months, for specified in-force contracts. A specified equity-market stress was estimated to reduce annual pre-tax operating earnings by approximately 4%–6%.
Key risks include sustained low interest rates, spread widening, investment impairment and valuation assumptions, policyholder behavior and guarantees, foreign exchange movements, credit and real-estate exposures, regulatory changes, litigation, reinsurance and cyber or operational events. The company estimated that a 10% adverse currency move would reduce international operations’ first-half pre-tax operating earnings by $17.4 million and their equity by $314.3 million.
First-half available-for-sale security impairment losses were $58.1 million, compared with $13.5 million in 2015, including increased credit impairments in energy and structured securities. Gross unrealized losses nevertheless declined to $440.0 million from $823.2 million at year-end; management attributed the improvement mainly to lower interest rates and said it did not expect to be forced to sell impaired securities before cost recovery.
New consolidation guidance, adopted January 1, 2016, deconsolidated $8.6 billion of assets and liabilities in certain Chilean retirement funds and brought certain sponsored funds onto the balance sheet, including $180.1 million of assets and $179.5 million of redeemable noncontrolling interest. Management said the changes did not materially affect operations or retained earnings.
On June 28, 2016, a bankruptcy court dismissed with prejudice all claims against Principal Life in litigation arising from Lehman Brothers structured transactions; the estate’s claim had been approximately $600 million including interest. A separate mutual-fund excessive-fee lawsuit against Principal Management Corporation remained pending. Management reported no legal accrual for the matters discussed, citing that losses were not considered probable and estimable.
Potential guarantees include approximately $170 million of maximum exposure under certain third-party agreements, which management considered remote in likelihood of material payment. The future maximum exposure under a required minimum-return guarantee for Chilean pension funds is indeterminable.

Important facts for investors to verify

How much of reported earnings growth reflects recurring segment performance versus volatile realized gains, derivatives, reserve movements and tax items.
Whether fee-based retirement and asset-management revenue stabilizes as markets and average account values change, and whether insurance growth continues with favorable claims experience.
Credit quality, impairment trends and concentration risks in fixed maturities, energy and structured securities, commercial mortgages, and international investments.
Capital and cash available at the holding company, subsidiary dividend constraints, debt maturities, and continued execution of the $400 million share-repurchase authorization.
Whether low rates, rising-rate-driven surrenders, foreign-exchange changes, guarantees, litigation, and regulatory implementation affect future earnings or liquidity beyond management’s estimates.