Interest Rate Declines ‘Not Helpful,’ Prudential CFO Says
February 10, 2015 by Cyril Tuohy, cyril.tuohy@innfeedback.com
Every so often a nugget of an understatement glimmers from the dense jargon of earnings conferences like a speck of tarnished gold in a prospector’s pan.
Last week was such a week, when Robert Michael Falzon, Prudential’s chief financial officer and executive vice president, told an analyst in a conference call that lower interest rates were making life very difficult for the life insurance giant.
“To state the obvious, further declines in interest rates are not helpful, but I would be careful not to extrapolate the fourth quarter sensitives,” Falzon told Citigroup analyst Erik James Bass about investment hedges.
In fact, the subject of interest rates — usually referred to these days in the context of lower rates — was referred to 25 times in last week’s conference call.
A rising dollar is simply compounding the projection challenges.
Of this we can be certain: Lower interest rates appear to be driving the insurance C-suite as well as the analysts absolutely nuts.
For Prudential and the analysts who follow the company, last week’s drama wrought by interest rate changes began after the market closed Feb. 4. That’s when the company released its fourth quarter and full-year 2014 earnings.
The consensus analyst forecast for fourth quarter earnings was for $2.38 per share, but the forecast collapsed and quickly turned into a rout as the company delivered $2.12 per share, an earnings “miss” of nearly 11 percent.
As the shockwaves reverberated after hours among Wall Street, analysts scrambled to redo their spreadsheets in preparation for the Feb. 5 Q&A with Prudential’s executives.
At the opening bell, investors punished the stock, which experienced declines during the day of more than 5 percent.
During the conference call, analysts seem to be having a hard time figuring out Prudential’s reported hedges and foreign exchange positions in an attempt to paint a picture of the company’s latest financial numbers and reconcile them with December forecasts.
With Prudential reporting a $1.5 billon drop in estimated excess capital capacity from earlier forecasts in December, analysts were flummoxed.
Nigel P. Dally, a managing director at Morgan Stanley, was said to have called the decline in capital capacity “mysterious.”
But it was left up to analyst Suneet L. Kamath of UBS to step up and put into words what many of the analysts were likely feeling: “I apologize, maybe I’m sleep deprived, but I’m confused in terms of this whole capital capacity thing,” he said.
If Falzon and the lieutenants in charge at Prudential projected more certainty than some analysts in connecting lower interest rates to the drop in capital capacity and the underwhelming quarterly financial results, they betrayed the difficulty of projecting future capital needs in an era of interest rate volatility.
For example, Falzon said that extreme interest rate volatility over the past several weeks meant that interest rate movements whipsawed by as much as 20 and 30 basis points every week. As a result, the company’s capital ratios change rapidly.
Falzon said recent interest rate declines had a negative impact on the company’s “underhedge.”
The underhedges are used to manage a portion of Prudential’s variable annuity interest rate risk, but as rates declined, they triggered changes in the company’s capital requirements and that sent company managers scrambling for funds at the holding company level, company officials said.
Lower rates in the fourth quarter also caused “a higher statutory provision based on year-end asset adequacy testing,” Falzon said.
Mark B. Grier, vice chairman and a member of Prudential’s Enterprise Risk Committee, also said that lower interest rates “have resulted in an increase in the amount of debt that we characterize as capital.”
In the fall of 2013, as interest rates began to rise, insurance carriers were turning in better earnings on their fixed-income portfolios and some market observers were heralding the end of an extended period of low interest rates as the Federal Reserve stopped buying bonds with the improving economy.
Instead, rates continued to drift downward last year, and have continued to drop since the beginning of the year.
