Prudential Downplays $1.5B Capital Loss in 4Q
February 5, 2015 by Arthur D. Postal, arthur.postal@innfeedback.com
WASHINGTON – Prudential Financial reported a 3.6 percent decline in fourth quarter earnings compared to the year ago — a precipitous 10.9 percent in consensus earnings estimates by analysts for the quarter.
But what stunned analysts was its disclosure that the company reported a $1.5 billion drop in estimated excess capital capacity from what it projected in December.
The disclosure of weaker earnings led Prudential’s stock to decline at some points during the day more than 5 percent despite the fact that the markets were strong overall.
In overnight comments, Morgan Stanley analyst Nigel Dally called the decline “mysterious.”
In a statement on the fourth quarter results, Prudential attributed the drop largely to a pre-tax loss of $2.4 billion in changes in the foreign currency exchange rates, mostly in Japan and Australia.
“Due to our recent implementation of a new reporting structure in Gibraltar Life that aligns functional currencies for its U.S. and Australian dollar-denominated business with the underlying products and investments, we expect that the impact of these currency-driven value changes on net income or loss will be substantially mitigated commencing with financial reporting for the first quarter of 2015,” according to the statement.
Just as the company was confident of a bounce-back this quarter, some analysts were also sure of an upturn. In comments after the company’s conference call on the fourth quarter, John Nadel, a Sterne Agee analyst, said that “the fourth quarter earnings per share shortfall compared to expectations was largely a result of seasonal factors and some elevated expenses, which leaves us confident our 2015/2016 revised earnings estimate are sufficient.”
But, he said, the volatility inherent in Prudential’s capital capacity owing at least in large part to the decline in longer-term interest rates is not insignificant. He said Sterne Agee is still maintaining Prudential as underpriced and a buy.
However, he said, “We believe investors will have trouble gaining confidence in Prudential’s excess capital levels — particularly with Fed capital standards on the horizon.”
The company reported fourth-quarter 2014 operating net earnings of $2.12 per share, and explained that the higher costs of doing business reduced earnings even though revenue was higher than the year-earlier period.
The company said the decline in net was due to lower contribution from individual annuities, individual life insurance and group life. For example, Prudential took a $68 million pretax charge against individual annuities, among some smaller charges. The sum knocked $0.21 per share off of results, roughly the size of the earnings miss, according to one analyst.
Including one-time items, the company incurred loss of $2.69 per share in the quarter, wider than the 94-cent loss incurred in the year-ago quarter.
However, total revenue increased 44.2 percent year over year to $15.8 billion primarily on higher premium, higher policy charges and fee income, and net investment income. Revenues were higher than projected by analysts.
Nadel said the drop in excess capital capacity was prompted in a drop in long-term rates since the December projection of 2.6 percent interest rate using a 10-year forward curve to the 2.19 percent at year-end 2014. This resulted in a decision by Pru management to reduce incremental capital capacity to reflect cash flow testing and concerns that it had under-hedged its variable annuity risk.
“These two items required funding of roughly $2 billion, which therefore increased financial leverage above the 25 percent target compared to the 29.6 percent actual factor,” Nadel explained.
