Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

MetLife, Inc. (NYSE:MET)

Q1 2009 Earnings Call

May 1, 2009 8:00 am ET

Executives

Conor Murphy – IR

Rob Henrikson – Chairman, President and CEO

Steve Kandarian – EVP and Chief Investment Officer

Bill Wheeler – EVP and CFO

Stanley Talbi - EVP

Lisa Weber – President, Individual Business

Bill Mullaney – President, Institutional Business

Analysts

John Nadel - Sterne, Agee & Leach

Colin Devine - Citigroup

Thomas Gallagher - Credit Suisse

Suneet Kamath - Sanford Bernstein

Jimmy Bhullar - J.P. Morgan

Mark Finkelstein - Fox-Pitt Kelton

Operator

Ladies and gentlemen, thank you for standing by and welcome to MetLife's first quarter earnings release. (Operator Instructions)

Before we get started I would like to read the following statement on behalf of MetLife:

Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws, including statements relating to trends in the company's operations and financial results and the business and the products of the company and its subsidiaries. MetLife's actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties, including those described from time-to-time in MetLife, Inc.'s filings with the U.S. Securities and Exchange Commission.

MetLife, Inc. specifically disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise.

With that I'd like to turn the call over to Conor Murphy, Head of Investor Relations. Please go ahead.

Conor Murphy

Thank you, [Julie]. Good morning, everyone. Welcome to MetLife's first quarter 2009 earnings call. We are delighted to be here this morning to talk to you about our results.

We will be discussing certain financial measures not based on generally accepted accounting principals, so-called non-GAAP measures. We have reconciled these non-GAAP measures to the most directly comparable GAAP measures in our earnings press release and in our quarterly financial supplement, both of which are available at MetLife.com.

Our reconciliation of forward-looking financial information to the most directly comparable GAAP measure is not accessible because MetLife believes it is not possible to provide a reliable forecast of the net investment-related gains and losses, which can fluctuate from period to period, and may have a significant impact on GAAP net income.

Joining me this morning on the call are Rob Henrikson, our Chairman and Chief Executive Officer, Steve Kandarian, our Chief Investment Officer, and Bill Wheeler, our Chief Financial Officer. After our brief prepared comments we will take your questions and here with us today to participate in the discussion are other members of management, including Bill Mullaney, President of our Institutional Businesses, Lisa Weber, President of Individual, Bill Toppeta, President of International, and Bill Moore, President of Auto & Home.

With that I'd like to turn the call over to Rob.

Rob Henrikson

Thank you, Conor, and good morning, everyone.

During the first quarter MetLife generated $7.9 billion in premiums, fees and other revenues, a solid result in what continued to be a challenging environment. Obviously, the pressure from unfavorable equity and credit markets had an impact on earnings; however, our mix of business is well balanced and our business model and fundamental remain solid.

In a few moments I'll talk about the actions we continue to take to ensure our financial foundation remains strong, but first I want to provide some insight into the performance of our businesses.

The Institutional business generated a solid top line result as premiums, fees and other revenues were $3.9 billion for the quarter. This strong result was driven by a 5% increase in both group life and in non-medical health premium, driven mainly by organic growth. Our Institutional business has been built on years of strong, trusted relationships with our clients. In tough times like these, relationships become even more important. We are spending more time with our customers and the advice we provide is even more valued.

Individual business earnings continued to be impacted by declining equity markets; however, fundamentals remain strong and we continue to benefit from a flight to quality. Variable annuity deposits increased over both the first quarter of 2008 and sequentially to reach $3.7 billion. In addition, we continued to see significant demand for MetLife's fixed annuity products, with deposits of $3.6 billion. Annuity net flows remain positive by almost $1.9 billion in variable annuities and $2.7 billion in fixed annuities. Both are benefiting from strong sales and declining lapse rates.

In International premiums, fees and other revenues declined over the year ago period, entirely due to the strengthening of the U.S. dollar against other foreign currencies. On a constant currency basis, revenues increased 3% over the prior year period, due mostly to solid performance in the Europe and Asia-Pacific regions despite volatile markets in a number of countries.

As I said, the underlying fundamentals of our business are solid and we remain focused on strong underwriting and expense management. I am pleased with the continued progress in our cost reduction and efficiency initiatives through operational excellence and remain confident that we will reach our goal of at least $400 million of annualized cost savings by 2010.

Now I want to talk a little bit about the Treasury capital programs and our own capital strength. As you know, MetLife has been a federally chartered bank holding company since 2001 and with more than $1 billion in total assets, we are one of the top 19 U.S. banking organizations participating in the Treasury's capital planning exercise being conducted under the Capital Assistance Program. We are working closely with the Federal Reserve on this exercise and will share more information with you as soon as possible.

As a bank holding company, we were also eligible to participate in the Capital Purchase Program; however, as we announced last month, we have elected not to participate in this program. Let me tell you why.

At MetLife we are confident that we have the financial strength to continue to succeed now and over the long term. We are well positioned, with significant excess capital, a strong balance sheet, and leading market positions in our core businesses, where our revenues continue to be healthy. We have continued to take actions to reinforce our financial strength. Aside from our capital raise in the fourth quarter, we have already in 2009 successfully remarketed over $1 billion in debt, which was several times oversubscribed and completed an additional $400 million debt offering.

In a moment Steve Kandarian will provide more details on our investments, but I just want to say our portfolio remains well structured and defensively positioned. While the credit markets continue to be challenging relative to the size of our portfolio, our loss experience remains modest.

In summary, despite the tough environment, our businesses are performing well. MetLife remains well positioned to continue to meet the needs of our clients and has the capacity and the financial strength to further solidify its leading position in the industry.

And with that let me turn it over to Steve.

Steve Kandarian

Thanks, Rob.

I would like to spend a few minute reviewing variable investment income for the quarter, realized and unrealized losses, our real estate-related holdings, and hybrid securities.

First, let me start with a comment on variable investment income. Pre-tax variable income was lower than planned for the first quarter by $508 million or $321 million after DAC, tax and other offsets, principally driven by negative corporate joint venture and real estate fund returns.

The losses related to our corporate joint ventures were principally driven by 2008 year end equity valuations which flow through our Q-1 income statement. Real estate fund returns were negative due to the continued decline in property valuations. We estimate that property values have already declined 20% to 25%, with an expected peak-to-trough decline of 35% to 40% in total. While we expect some moderation in these returns, we anticipate that results from these sectors will remain weak, at through the end of 2009, and that we are unlikely to achieve our variable income plan for the remaining quarters.

On the other hand, income from our securities lending program continued to outperform plan. As of March 31st our securities lending book was approximately $20 billion, down from $23.3 billion as of December 31st. In addition, hedge fund returns improved from the fourth quarter and were slightly above plan.

Now let me cover investment losses for the quarter. Gross investment losses were $535 million, in line with the previous four quarters. Of this amount, $145 million were credit-related sales. Writedowns this quarter were $1.041 billion, including $754 million of credit-related impairments. These impairments were experienced across a variety of sectors, including $358 million in corporate credit, $136 million of equity, $126 million in structured finance securities, and $134 million primarily due to our strengthening of general mortgage reserves.

Non-credit-related writedowns of $287 million included $191 million of impairments on hybrid securities. These hybrid securities were impaired because they've been trading below 80% of amortized cost for more than 12 months and were downgraded to below investment grade in the first quarter. The remaining $96 million of non-credit impairments related to other equity securities which were impaired because of the length of time and the extent to which their market value has been below amortized cost.

When added together, total credit-related losses from sales and writedowns were approximately $899 million before income tax or $584 million after tax. Gross unrealized losses for fixed maturities were $28.8 billion at March 31st, essentially unchanged from December 31st. While spreads declined in the vast majority of sectors during the quarter, this was offset by an increase in interest rates.

For example, BBB in high-yield corporate bond spreads declined 38 basis points and 182 basis points, respectively. However, five-year and 10-year Treasury rates increased 11 basis points and 45 basis points, respectively. As spreads have continued to tighten, our gross unrealized losses for fixed maturities have declined by approximately $2 billion since quarter end.

Next I'd like to discuss our real estate-related holdings. As of March 31st we held Alt-A residential mortgage-backed securities with an amortized cost of $5.1 billion and a fair value of $3 billion, including 2006 and 2007 vintage securities with a fair value of $1.5 billion. As mentioned on the last earnings call, we expected that Moody's would downgrade virtually all 2006 and 2007 vintage Alt-A securities to below investment grade. Approximately 87% of our 2006 and 2007 vintage Alt-A securities and 60% of our total Alt-A portfolio were rated below investment grade at quarter end.

As noted on several occasions, we believe our portfolio has superior structure to the overall Alt-A market. For example, 87% of our Alt-A portfolio is fixed rate versus 36% for the market. Furthermore, we hold no option ARM mortgages as compared to 28% for the market. In addition, 83% of our Alt-A holdings have super senior credit enhancement, which typically provides double the credit enhancement of a standard AAA-rated bond.

As of March 31st we held commercial mortgage-backed securities with an amortized cost of $16.3 billion and a fair value of $13 billion. Based on fair value, 93% of these holdings are rated AAA and 86% are from 2005 and earlier vintages. Of the 2006 and 2007 vintage holdings with a fair value of $1.9 billion, 87% are senior or super senior securities with 20% to 30% credit enhancement versus 10% to 15% for standard AAA securities.

At quarter end MetLife commercial mortgage portfolio was $35.9 billion. As of March 31st, the portfolio loan-to-value was 59% based on a rolling four-quarter property valuation process or, we estimate, in the low to mid 60% range if all properties were revalued today. In addition, we also stress test the portfolio with peak-to-trough valuation declines of 40%, which shows our average loan-to-value increasing to the low to mid 70% range. In addition, our debt service coverage remains strong at 1.9 times.

To date real estate delinquencies and losses have been minimal. We had one loan default during the first quarter. In April we foreclosed on the property, taking a writedown of less than 15% of the loan balance, well below historical loss levels. In addition, only $2.2 billion of the portfolio matures in 2009. We are very comfortable with this level of rollover and expect to refinance and hold the vast majority of these mortgages as we refinance them at market rates.

Finally, let me say a few words about our hybrid holdings in financial institutions. At March 31st our Tier 1 securities had an amortized cost of $3.6 billion and a fair value of $1.5 billion and our upper Tier 2 securities had an amortized cost of $1.7 billion and a fair value of $919 million.

It should be noted that MetLife's hybrid portfolio is largely concentrated in top tier banking institutions. Moreover, our entire hybrid portfolio remains current on all interest and principal payments. Since the end of the first quarter hybrid security prices have increased as the fear of financial institutions defaulting has declined and several top tier financial institutions have called their securities at par.

Let me conclude by stating that we continue to be comfortable with our overall inventories portfolio. While we have seen some stabilization in the financial markets, we remain cautious and defensively positioned.

With that I will turn the call over to Bill Wheeler.

Bill Wheeler

Thanks, Steve, and good morning, everybody.

MetLife reported $0.20 of operating earnings per share for the first quarter. Despite the challenging economic environment our businesses continue to have solid results. This morning I'll walk through our financial results and point out some highlights as well as some unusual items which occurred during the quarter.

Turning to premiums, fees and other income, we had top line revenues - which we define as premiums, fees and other income - of $7.9 billion. This represents a decrease of 2.3% as compared to the first quarter of 2008. Adjusting for changes in exchange rates in International and lower pension close-out sales in retirement and savings, revenues would have been up by 4.1%. Given the current environment, I think this is an excellent result.

Institutional revenues were down slightly - 1.7% as compared to first quarter 2008. This was primarily due to lower pension close-out sales, which fluctuate from quarter to quarter. Group life premiums grew at 4.8% as compared to the first quarter of 2008 and non-medical health was up 4.6% versus the year ago period, driven by growth in the dental business.

International had reported revenues of $933 million in the first quarter compared to $1.2 billion in the year ago period. Changes in exchange rates had a significant impact on reported revenue. On a constant dollar basis revenue actually increased by 2.8% as compared to the first quarter of 2008, driven by Europe and Asia-Pacific regions.

Turning to our operating margins, let's start with our underwriting results. Underwriting experience was generally favorable this quarter. In Institutional, group life mortality of 92.9% was well within our guidance range of 91% to 95%. In non-medical health and other, group disabilities' morbidity ratio of 86% for the quarter was better than our target range of 89% to 94%, driven by stable incidence rates and strong claim management results.

Individual's mortality ratio of 82.6% is more favorable than our plan of 89% and that was driven by lower claim activity. If we adjust for the impact of reinsurance, our net mortality results were still favorable.

Turing to Auto & Home, the combined ratio, including catastrophes, was 92.4%, which reflects an uptick from the 90.8% experienced in the first quarter of 2008, but still below our planned ratio. Included in this result is a prior accident year reserve release of $17 million after tax, and that's compared to a $23 million after-tax release in the same period in 2008.

Catastrophe losses for the first quarter were $8 million after-tax higher than plan. The combined ratio, excluding the impact of catastrophes and prior year development was 91.7%, and that's a very favorable result and better than the 92.4% experienced in the prior year period.

Moving to investment spreads, with regard to variable investment income, as Steve has just explained, we again saw mixed performance in certain variable alternative asset classes this quarter. We experienced losses in corporate joint venture and real estate funds, driven by significant year end equity valuations, which flowed through our first quarter results. Securities lending margins were strong and hedge funds performed well, with both asset classes coming in slightly above plan.

For the quarter, variable investment income after DAC, tax and other offsets was $321 million or $0.40 per share lower than the 2009 plan. As Steve also mentioned, although we expect this area to improve, we probably won't get back to our plan.

Also due to market conditions, we continue to maintain high levels of liquidity. Cash and short-term investments totaled $30 billion at March 31st. This higher level of liquidity is also adversely affecting investment spreads.

Moving to expenses, our overall expense level was higher this quarter, but that was driven by high DAC amortization and higher pension and post-retirement benefit costs. The equity market decline of over 11% and interest rate movements in the first quarter reduced earnings through higher DAC amortization in Individual business by approximately $204 million after-tax or $0.25 per share.

Pension and post-retirement benefit expenses were approximately $80 million pre-tax higher than in the first quarter of 2008. At Investor Day last December we told you that pension and post-retirement benefit costs would increase by approximately $180 million in 2009 due mainly to weaker investment results. As we finalized our pension and post-retirement benefit calculations at the end of 2008 we also lowered our discount rate assumption and made some other adjustments. Using these revised assumptions, we now expect our pension and post-retirement benefit costs to increase by approximately $300 million in 2009.

Also this quarter we incurred $34 million pre-tax in operational excellence charges, which consisted mainly of severance payments and consulting expenses. The progress we are making in operational excellence is offsetting these higher pension costs I just mentioned.

Turning to our bottom line results, we earned $159 million in operating income or $0.20 per share. Given the results this quarter, we don't believe the earnings guidance we provided last December is still appropriate. We have decided not to provide updated guidance because of the volatile capital markets environment. That said, if you normalize our variable investment income and the equity market impact this quarter, I think you can get a good sense of our underlying earnings power.

With regard to net investment gains and losses, in the first quarter we had net realized investment losses of $760 million after tax and other adjustments and Steve has just explained that in great detail.

Our preliminary statutory operating earnings for the first quarter of 2009 are approximately $120 million and our preliminary statutory net income is $45 million.

In summary, the fundamentals of our business remain strong and we continue to deal successfully with the challenging market environment.

And with that, let me turn it over to the operator so we may take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Nadel - Sterne, Agee & Leach.

John Nadel - Sterne, Agee & Leach

A couple of quick ones, maybe a big picture one. I'm thinking about TARP and I'm thinking about the government's stress and MetLife's sort of open comment in a press release a week or two ago, whenever that was, a couple of weeks ago, that indicated that you had no intention of participating in TARP.

I know that this is a bit of a touchy situation, but what can we take away from that commentary and that decision as it relates to your expectations around the government's stress test? Should we feel more comfortable, should your investors feel more comfortable about the stress test in light of your advanced sort of commentary about not wanting to participate in TARP.

Rob Henrikson

I'm laughing at your question a little bit, John, because you know I can't answer it. But a little bit of color might be helpful here or kind of walking people back in terms of what we have said about TARP and whatnot. And I don't spend any time thinking about TARP, quite frankly.

You know, at the beginning, when we first had, out there in the marketplace, this discussion of TARP, which was a new program, we were asked about it and we said then and we've said consistently ever since then answers that essentially said MetLife has no comment. There was reason for that if for no other reason that it was our understanding that any activity relative to or conversations by anyone about anything about TARP was nonpublic information.

And we stuck to that and for quite a long period of time every time TARP was mentioned - and, of course, as time went forward, the discussions on TARP started to morph a little bit as to what it was. It was announced originally, I think the nomenclature TARP was very clear - Troubled Asset Relief Program - then it moved to the sense that this really couldn't work as quickly as the government hoped and so it sort of changed into capital injection, capital injection into healthy financial institutions that were large players in the credit market to help unfreeze the credit market and so forth. And if I recall there was even discussion about encouraging consolidation.

Time went forward, the definition and the requirements around TARP continued to change. And during all of that period we were asked periodically do you have anything to say other than no comment and our answer was no. And I think there were a lot of reasons for us wanting to do that. We just thought it was the appropriate thing to do.

The problem recently however with the new sort of rising interest in TARP relative to the insurance industry, there was quite a bit of press and discussion about TARP and who was eligible and who wasn't, and at one point people were connecting the dots and the facts became inconsistent with the messaging in the press relative to MetLife. And at that very point I felt well, this is not good; we need to set the record straight because by not saying anything or saying no comment, in effect we might be sending a message that the implications were correct and they were not. So we simply wanted to set the record straight.

So that's the whole story about TARP. And I mentioned in my comments about the stress test. There it's very specific that there is to be no discussion at all about the stress test by any of the participants. And I know there's been a lot of questions and people guessing as to who's on first and so forth. There we simply don't know, quite frankly, when the Fed will release, so that's my comment.

John Nadel - Sterne, Agee & Leach

Two other quick ones and thank you, Rob, for that, that's helpful.

Bill, you mentioned statutory net income was marginally positive for the quarter. Can we infer from that that risk-based capital, since there was only modest deterioration in the investment portfolio, that risk-based capital was generally flat from year end?

Bill Wheeler

Yes. If I had to guess I'd say it's a little lower. We did have positive statutory income. The balance sheet shrunk a little bit because we paid off some liabilities in our retirement and savings area, so that would have implied that RBC would have picked up a little bit. I think the ratings migration that Steve alluded to in a lot of asset-backed classes where stuff got re-rated from investment grade to junk, that's a strain. Underneath this there's a lot of other moving pieces.

I would just kind of tell you that RBC calculation is really complicated and so that's why, for instance, on Investor Day last year we didn't really want to guess a single-point number; I gave you a pretty wide range, because it is complicated. We only calculate it once a year.

So I think that the number is relatively steady. My guess is it's a little lower, but I don't really want to be much more precise than that. And we don't do the math every quarter and the math is complicated.

So, for instance, the fluctuations in interest rates have probably had a greater impact on some of the reserve calculations we have to put up, but we don't do those calculations until we do them - I think some of the reserves came down from year end, is what I mean. But we don't do that math every quarter.

The only other thing I'd add, by the way, since you brought it up so RBC may be down a little bit. Cash at the holding company is $1 billion higher than it was a year end and that's not coming from dividends from insurance subs, that's from some of the financings we talked about and we sold a little business and stuff like that. So if I think about our excess capital position I would say it's, you know, the $5 billion plus number that we sort of have out there, I think that's still an appropriate number.

John Nadel - Sterne, Agee & Leach

Last one for you. If you think about - and I'm sorry if I joined this late and missed, maybe Steve commented on this - but, Steve, if you think about the sort of very broad and in some cases material credit improvement during the month of April, can you give us a sense for what kind of improvement in your marked-to-market or your net unrealized losses you would sort of guesstimate if we marked the portfolio from 1Q to the end of April?

Steve Kandarian

Sure, John. I didn't give that comment, but it was about a $2 billion improvement since quarter end driven by tightening in spreads, although we have seen a little bit of an increase in interest rates, especially in the long end of the curve, which offsets the number but it nets down to about $2 billion.

Operator

Your next question comes from Colin Devine - Citigroup.

Colin Devine - Citigroup

First, with respect to the VA hedging, Bill, can you just run through one more time specifically what you do on the GMIB and particularly how you hedge for the dollar-for-dollar withdrawal feature on that is question one.

Question two, for Steve, if you could give us some idea of where you were putting new money during the last quarter in terms of investments and duration.

And then for Rob, you know, given the continued ramp up in the pension costs, perhaps you can give us some thoughts on does it still make sense for Met to have a defined benefit pension or is this something that you should be looking at doing yourselves, closing it down?

Bill Wheeler

Okay, Colin, I'll start about the VA hedging and specifically talk about the dollar-for-dollar.

Colin Devine - Citigroup

Yes, particularly focus on GMIB.

Bill Wheeler

Yes, GMIB. Well - and Stan's sitting here next to me, so he'll correct me when I say something wrong - remember, now, GMIB, the accounting there is SOP 03-1 and so the ability to hedge to the accounting and the economics, it's a little looser than if it was a withdrawal benefit product where you could use FAS 133 where we can do everything much more tightly.

So in general for GMIB we use obviously a portfolio of S&P put options in general. We also, to kind of, I would say, hedge the longer-term economic risk, we also buy some long-dated S&P put options to kind of also hedge more of the economic risk as opposed to just focusing on the accounting.

So that's in general how the hedging works there. It's hard for the hedges because of the accounting convention of SOP 03-1, it's hard for the hedges to be perfect, but our track record is that we actually do a pretty effective job of matching off and that we have very little breakage or noise around that hedging program.

Colin Devine - Citigroup

Bill, can we just specify - I just want to make sure that I'm hearing this very clearly - are the economics here driving your hedge program or is it the accounting and what here is properly hedged, the economic exposure or the GAAP results?

Bill Wheeler

My smart aleck answer is yes.

Colin Devine - Citigroup

It sounds to me that you're hedging the accounting and I want to get at, with these movements in interest rates and the decline and I'm glad you've got Stan there, is how much has the economic exposure moved for Met, particularly given - and also to talk about the experience on the dollar-for-dollar withdrawal and how you're trying to hedge for that.

Stanley Talbi

Okay, Colin, let me try to help answer that. In addition to what Bill said, clearly we're direct hedging the GAAP accounting because we don't want to create volatility in our income statement, but we supplement the direct hedging with capital markets reinsurance and that capital markets reinsurance is what protects us against catastrophic movements in the equity market and interest rates on the piece that we're not able to directly economically hedge.

In terms of dollar-for-dollar withdrawals, we do have models that predict policyholder behavior depending on how much the benefits are in the money and that kind of helps us estimate what the dollar-for-dollar withdrawal effects would be in different economic environments, and that's kind of built into our direct hedging program as well as our reinsurance program.

Colin Devine - Citigroup

And can you give us some sense of how the economics are unfolding here versus the accounting?

Stanley Talbi

Both parts are doing well. As I said, we do have a reinsurance program which is more catastrophic in nature. And we've determined that we could absorb some losses in our income statement, but we're more worried about the tail risk and that's pretty much what we hedge.

So in terms of the economics, we do have some noise there, but it's all very manageable and it's all measured and it's really the tail risks that we've hedged against.

Colin Devine - Citigroup

The tail, not the drop in interest rates?

Stanley Talbi

It's a combination of a drop in interest rates.

You know, for the GMIB benefit to be in the money you have to have either a catastrophic reduction in the equity market.

Colin Devine - Citigroup

Okay, we're there on that.

Stanley Talbi

Or a big reduction in the equity market and lower interest rates.

Colin Devine - Citigroup

Okay, well that kind of sounds like the current scenario, but maybe we can keep moving on.

Bill Wheeler

I don't want to leave it there. Interest rates have to be even lower than they are now effectively and that's a little bit about what's going on there.

You remember, too, you know, and we did this on Investor Day - Stan's trying to cut back in, but I'm not letting him; I'm just going to monologue this - remember on Investor Day we also talked about how the GMIB product, is designed and how we think that's a very favorable design in terms of the assumptions built in regarding mortality and stuff. You know, a lot of times that doesn't get appreciated about GMIB, and I think that's part of the reason - obviously, GMIB is our most popular rider by a long ways, so that I think gives us some additional comfort about sort of the real economic risk here.

Colin Devine - Citigroup

I always like hearing from the actuaries, though.

Stanley Talbi

Yes, and if I could just remind you, Colin, you know, at Investor Day Bill showed some slides showing how conservative the purchase rates are in the contract and, in fact, on May 1st we made some modifications to make them even more conservative.

Colin Devine - Citigroup

I would say some modifications is an understatement.

Steve Kandarian

Okay, Colin, I'll take up the next part of it. You asked for the new money for the first quarter. Most of it went into governments and agency backed RMBS, so those were low-yielding assets that were quite safe and we felt like that was the right thing to do in the first quarter, to remain very liquid in safe assets. There was some investing into high-quality corporate bond, investment grade bonds in defensive industries.

Colin Devine - Citigroup

And what about mortgages?

Steve Kandarian

Mortgages went up a little bit and the things we looked at with mortgages, we'd take a look at what we believe were both current market valuations today, meaning down 25% from the peak or so, and we stress tested them down further to 40% from the peak, which actually means below where they started in terms of the run up this last several years. And we tried to do things in kind of the 50%-ish range in terms of loan-to-value and that basis, with very strong coverages and, when we looked at the tenant role, very strong tenant rosters, no big tenants dominating the properties so, again, with an eye really toward preservation of principal.

For the second quarter - you didn't ask about this, but I think your question kind of begs it - in the second quarter we'll probably ease a little bit back into some more spread assets, but still very much with an eye toward principal preservation after taking into account, again, some severe stress tests on the assets before we purchase them. So we could end up going back into things like CMBS, but only those that are trading down extremely hard, you know, very high quality securities after being stressed, virtually no chance of losing principal. The only question there would be how much money you'd make on the upside.

We've modeled those things out. We're starting to see things we think that could make some sense in terms of principal preservation, remaining defensive, and getting a chance to get our yields up a little bit.

Rob Henrikson

Okay, I'll take the third one, Colin. You gave me so much time to think about it.

Colin Devine - Citigroup

I bet every employee at Met's listening to this.

Rob Henrikson

I could have retired by now just thinking about it.

First, just a slight look back. Those who've been following the company - I know you would recall - that when we became a public company we did quite a review of all of our employee benefit plans. The defined benefit plan was essentially left open for people who were currently members but closed to new members. We changed the shape and form to a cash balance plan and so forth. So for the plan that is closed to new members, it eventually - in other words, it doesn't really increase in terms of expense going forward because it's closed.

And so having said that, however, what we do each and every year is continue to review the total value proposition relative to talented employees and so forth, compensation in general, the employee benefit plans here, relative to your question specifically, and we will continue to do so. The total value proposition is very important when we look not only at certain parts of our company but all across the board, including our sales forces. But relative to operational excellence, relative to everything else we're doing, the employee benefit plans are definitely in scope.

Keep in mind we're in this business not only as an employer but we give terrific advice to a massive book of business relative to employee benefit plans, mostly to public companies, and we certainly go about following our own advice.

Operator

Your next question comes from Thomas Gallagher - Credit Suisse.

Thomas Gallagher - Credit Suisse

I wanted to start out on the commercial mortgage loan side. Steve, can you talk about - I know you mentioned you increased balances of commercial mortgage loans a little bit this quarter. Is what you're putting to work there pretty much just rolling over existing loans or are you actually putting out new money on new loans?

And can you talk a little bit about of your rollover portfolio, the loans that are actually maturing this year, can you give us an idea of overall how you're looking at that? Are you going to just roll over the vast bulk of it? Is there a portion of it you're not? You know, talk a little bit about risk of foreclosure and how things are looking there. That's my first question.

Steve Kandarian

We've done both in terms of rollover and new loans. But again, the new loans we're looking at and considering for extending credit to are very low loan-to-value after being stressed and there's not a lot of activity because those who don't have to refinance are holding on right now.

So we've seen sort of a decline in activity in both directions, meaning in the heated period of 2005, 2007, we had a lot rolling off prematurely because they'd refinance at lower rates or more aggressive terms as to loan-to-value, so we're seeing very little of that right now, so the portfolio's pretty stable - as I mentioned, $2.2 billion anticipated in roll off coming up here. And we've looked at the loans that are rolling off and in virtually all cases we're very comfortable with those credits, with the loan-to-values, with the tenant rosters in those cases, with the sponsors, equity sponsors and the amount of equity below us.

So we would anticipate in most or all cases we would actually extend credit on terms that we find attractive at yields that we find attractive.

Thomas Gallagher - Credit Suisse

Steve, can I interrupt you there? As you're rolling these loans, the $2.2 billion, are you getting meaningfully higher yields? How is that playing out, because I'm just curious if you're doing it at existing rates? Is it at a subsidy or what's going on?

Steve Kandarian

No, we're doing it at market rates, so they are very attractive yields, higher yields than we've had in the past several years.

Thomas Gallagher - Credit Suisse

And would that be north of 8%, north of 9%?

Steve Kandarian

It's generally right now in the 7s.

Thomas Gallagher - Credit Suisse

And you consider that market rate?

Steve Kandarian

Given to loan-to-value of the properties we're talking about, yes.

Thomas Gallagher - Credit Suisse

One other follow up on that is I think the comment was $134 million of commercial mortgage reserves. Just curious, is that related to specific delinquencies or foreclosures and what does that imply for your mortgage experience adjustment factor on RBC? Are you at risk of tripping that?

Steve Kandarian

The number's actually $110 million. I gave you $134 million in total for real estate, $110 million of that was the strengthening of mortgage reserves.

And, I'm sorry, the rest of your question?

Thomas Gallagher - Credit Suisse

Is that related to specific delinquencies or potential foreclosures and would that trip you up with the MEAF calculation for RBC?

Steve Kandarian

It relates to looking at the overall portfolio, certain loans we felt should have additional reserves strengthening against them. In terms of tripping up, I don't think that, at this point - there's just one delinquency, so at this point we don't think that's going to be an issue.

Thomas Gallagher - Credit Suisse

The last question I had was just on cash. I don't know -

Steve Kandarian

Tom, let me just add one more comment before we move on to a different topic. When you see yields in terms of new loans being written, most of the properties we're talking about here are very high-quality properties, kind of A properties in the top markets. So if you hear someone else on an earnings call talk about they got an 8% yield, that could be in a B market, that could be a property that's not very attractive, that could be high loan-to-value. There's a whole bunch of factors that go into what the appropriate yield is on these different kinds of mortgages, so please remember that we're talking about very high quality properties with strong sponsors, low loan-to-value, and in the top markets.

Thomas Gallagher - Credit Suisse

Understood. Last question for either Bill or Eric, if he's there, just on cash and what happened. It looks like cash and short-term went down by about $8 billion. Is that because you're redeploying or was that the $5 billion net redemption in global GICs?

And then can you also comment on what's going on with the FHLB because I think you borrowed something in the $15 billion ballpark. Should we expect that that's going to remain outstanding?

Bill Wheeler

I'll take that. So with regard to cash, we had $38 billion of cash and short-term at year end and now the comparable number's down to $30 billion, so that's the $8 billion decline.

Now of the $38 billion, $8 billion of that is actually cash that's sitting as collateral for derivatives with our counterparties. You know, a lot of our derivatives, as you can guess, are way in the money, so that collateral sits there. That $8 billion has declined for a variety of reasons down to $4 billion at March 31st. So, if you follow the math here, our cash balance has actually declined now  our real cash balance, if you will - has declined from $30 billion to $26 billion.

So, where did it go? It's been put out in investments so I think you get the sense from Steve that we're tiptoeing our way back into the credit markets a little bit. I think most of that probably went into agency securities.

Now we did at the same time repay - and you see this in the roll forward chart in retirement savings - we have repaid some GICs and some funding agreement backed securities that matured in the second quarter and we repaid those liabilities from the securities that were assigned to them. We have to use - especially in global GICs - we have to have very tight asset-liability matching. It's a separate portfolio. And so when stuff matures there's assets that also mature at the same time to pay it back. So, I mean, cash is a little fungible in some way, but that's sort of how it played out.

With regard to the FHLB, you know, the balances really didn't change very much this quarter. Some of it rolled. We also extended some of the FHLB balances out into 2010, so some's rolled, some we've extended. Our expectation is that we're going to keep drawing on those lines for probably the remainder of this year. Certainly in the current environment we want to be drawing on the lines and we want them to have that cash, so that's my expectation.

Operator

Your next question comes from Suneet Kamath - Sanford Bernstein.

Suneet Kamath - Sanford Bernstein

First, going to the equity market exposure, I guess we're getting a sense of what that does to your earnings on the way down, but can you just talk about how, say, a recovery in the markets, if we're up more than your 1.5% to 2% appreciation assumption in a quarter, how that'll impact both the GAAP earnings and the STAT earnings?

And then a separate question related to the VA market. I guess there were some comments earlier about some changes that you were making. You didn't get too specific on them and I was hoping that you could do that. Really, what are you doing at the VA in terms of pricing, how much is it going up and what sort of restrictions are you implementing and how do you think about what you're doing relative to what you're seeing in the market if you have any color on that?

Bill Wheeler

Maybe I'll talk a little bit about accounting and then I'll let Lisa talk about the VA product and the changes we've recently made.

Obviously, March 31st the S&P ended the quarter right about 800 - and, I don't know, it's 870 something, right, as of yesterday - and it had begun the year, December 31, 2008 it was almost exactly 900, so we've gotten almost all the recovery back - not all, but close - and obviously the stock market recovered a lot higher than sort of our 1.25%, so how does that affect the numbers?

Well, obviously that decline in separate account fees, which we would have seen if the stock market had stayed at pretty much 800, that decline is now going to be very muted, so you'll see higher fees throughout the remainder of the year because of that and that'll obviously sort of, you know, help our earnings recover a little bit more than our base assumption, so that's good.

The second thing is you'll see some DAC adjustment going the other direction. Obviously, when you have a decline in the market you have higher DAC amortization. There'll be some slowdown of that when the market moves the other direction, but you don't get it all - unfortunately because of where we are relative to sort of what I would call the base case, we don't get it all back. So that $0.25 that I talked about which was really an adjustment for equity markets, you'll get a piece of that back if the equity markets stay where they are in the second quarter, but probably not even half I would guess. But you'll get some back.

I don't know. Was that clear? That's probably as clear as I want to make it at the moment.

Suneet Kamath - Sanford Bernstein

Okay, that's fine. Can we go to VAs, then?

Lisa Weber

Sure. In terms of the VA market, we continue to see that business as strong for us with the flight to quality and people looking for safe havens. As you know, we did take pricing action in February and, as commented earlier, further benefit changes in May which are really very significant. May 4th we are decreasing the step up, which is probably the most significant change from 6% to 5%. We're also decreasing the period certain on the GMIB annuitization from 10 years to 5 years, we're increasing the age setback from 7 to 10 years, and we're modifying the portfolio flexibility from 85/15 equity fixed to 70/30. The no-lapse guarantee is going from age 60 to 62 and it'll still be at 100 basis points.

So those are the changes. They are significant. We still continue to see ourselves in the enviable position because we're comfortable both with our product offering as well as our pricing, our hedging, which was commented on earlier, and very significantly our strong and broad distribution, which continues to bode really well for us, particularly in this market. When many other firms are letting go of wholesalers, our wholesaling force has stayed strong, has stayed loyal, it's stayed dedicated as has our affiliated field force. And so as I mentioned, we are continuing to gain market share. So we're positive as we go forward here.

Suneet Kamath - Sanford Bernstein

Maybe just a follow up for Lisa or Stan, those are quite a few changes, so as -year-old think about rolling those changes through to the economics of the product, what does that do to the returns of the variable annuity in sort of a more normal equity market environment?

Lisa Weber

Let me just comment first and then I'll pass it over to Stan. The price increases, the fee increases that we made in February were really in response to the volatility of the markets. These benefit changes are more in response to the interest rate changes and we are confident that with these changes we'll regain profitability.

Stan, do you want to answer further?

Stanley Talbi

Yes. The reinsurance we had in place was kind of like the equivalent of long-dated options so we were protected at least on that part with the increasing volatility and changes in interest rates. So these changes are really to restore profitability going forward at the levels that we like, so it's really to get back up to our targeted returns given the changes in the market in both interest rates and volatility.

Suneet Kamath - Sanford Bernstein

And then one last quick one for Steve. The $2 billion number in terms of the decline in gross unrealized losses, is that sort of pre-tax and pre-DAC or is that net of that stuff?

Steve Kandarian

That's a pre number.

Operator

Your next question comes from Jimmy Bhullar - J.P. Morgan.

Jimmy Bhullar - J.P. Morgan

I had a few questions, first for Bill. I think this was asked, but I'm going to ask it in another way. On earnings, if you take out the DAC expense being high and normalize [inaudible] income, I think you're in the low 80s, maybe $0.83 for the quarter. You mentioned in the second quarter fee income should get better, maybe DAC will be a little bit lower, but on the hand your variable [inaudible] income should be weaker than what's implied in that 83, which is probably the $150 million [guidance]. So directionally, should we expect the earnings to rebound with the rebound in the market? My expectation is that they should actually be lower, but if you can comment on that one.

Secondly, for Steve, I think MetLife's talked in the past about realized investment losses being about 1% of the portfolio in 2009, which would imply $3 billion for the year. This quarter I think it was $584 million pre-tax roughly - or after tax - $900 million pre-tax, so you're running a little bit higher than that, what your expectation is for the rest of the year.

And finally for Bill Mullaney on retirement and savings, your sales this quarter were very strong, mostly driven by structured settlements, but I'm assuming close-out activity was weak and if you could just talk about your expectations for closeout sales given that rates are pretty low and most plans are underfunded, so most likely I don't think there should be a pickup in sales as the year goes on.

Bill Wheeler

Well, Jimmy, I'll go first. So we reported $0.20. We talked about the miss versus plan on variable investment income being worth $0.40 and then the equity impact in the equity linked products being $0.25. If you just take those moving pieces you get $0.85. Now, there's a whole bunch of other noise which nets, I think, to sort of a negative $0.02, if you will, so that's your $0.83.

Now a couple of things to keep in mind about that. The $0.40 miss, that's versus plan. Now, you heard both Steve and I talk about we don’t think we're going to get the plan for the remainder of the year and I don't think we will. In the second quarter, where we have some visibility now, we don't think we'll get back to plan, okay? It's going to be a meaningful improvement over the first quarter and I think we'll get most of that $0.40 back, but I don't think we're going to get it all back. So that would imply that sort of the run rate isn't in the 80s, it's lower. I mean, maybe it's in the 70s.

Now where the equity markets are at, I mean, obviously that'll help a little bit on the margin if the stock market stays high but who knows? We have a couple more months to go here yet in the quarter.

And the other thing that I think that's sort of out there that I just want to make sure to mention is the cash levels we're holding - and even when some of our money which isn't in cash, you know, it's in fairly low-yielding very safe highly liquid sort of Treasuries and agencies - this conservatism, which I think is appropriate, it's costing us money, though. And it's always a little hard to calculate exactly how much that's costing you a quarter, but it's at least $0.10 a quarter and could be more.

We're also not going to change that situation right now. I think we will change it eventually, but certainly not in the second or third quarter we're probably not going to change it very much.

So hopefully that'll give you a little sense of sort of what I think the run rate might be and sort of one of the other issues around it in terms of current earnings power.

Steve Kandarian

Jimmy, as to realized losses going forward, it is difficult to know whether the 1% number will [inaudible] come out or not. I mean, it could be somewhat higher. It really depends on how things unfold here in the economy in the coming quarters.

Some of the likely places we'll see some stress would be the hybrid area. As we said, it's improved a little bit since quarter end, but let's see where that comes out. Loans related to more leveraged corporate credit could be an area you'll see some stress over the course of the year, and a few other buckets that might be under pressure.

So it's just very difficult to say precisely where these things will come out, but I think the 1% or somewhat higher area is what we're talking about.

Bill Mullaney

Just to give you a little color on closeouts, you did hit on some of the key points that we're seeing in the marketplace. Obviously with equity markets down in 2008 the number of plans that are now in underfunded status is up and the low interest rate environment obviously does have an impact on prices. But having said that, there are some plans that remain fully funded and we've been in active discussions with a number of plan sponsors around some of these opportunities.

You know, the fundamentals of this business don't really change in terms of assessing the underlying liabilities and then doing the analysis around the pricing, so I would say we still remain very comfortable with this market. We're willing to do deals at the right prices and we have the capital to be able to do that, so we continue to be in the market. There are some active discussions and we're optimistic that we may see some deals take place in 2009.

Operator

Your last question comes from Mark Finkelstein - Fox-Pitt Kelton.

Mark Finkelstein - Fox-Pitt Kelton

I guess, Bill, first question, could you just help explain how STAT earnings were positive in the quarter? It surprised me a little bit. I mean, I guess what I'm really getting out without wanting a reconciliation but rather were there any single notable items that we should pay attention to?

Bill Wheeler

Yes, that's a good point because it isn't obvious why we would have GAAP net losses and STAT positive earnings.

So remember now, when we take an impairment we impair both for GAAP and STAT and we've always done it that way and I think everybody else is supposed to now follow us and do it the same way we do - that's my impression. But what you don't see is remember in the last quarter we had some very big derivative gains because of some interest rate floors and swaps we had which went way in the money. We have used those as hedges against some of our minimum interest rate liabilities. So while Treasury rates were so very low, overall interest rates, factoring in credit spreads, were still relatively high.

But we had this gain so what we decided to do in the first quarter is pocket some of that gain because in GAAP, of course, as the change in the value of the derivative flows to the income statement, but STAT, you know, it's when you actually sell it. So we sold some of those derivatives or cashed them in, if you will, in the first quarter and we pocketed the gain and that basically offset the billion dollar impairment that we took on a GAAP basis.

So we did have some very small realized investment losses on a STAT basis, but net income was therefore still positive.

Mark Finkelstein - Fox-Pitt Kelton

And I guess just following on that, what kind of risks are there in terms of interest rate changes that, by selling the derivative we take going forward in earnings?

Bill Wheeler

Well, it's funny. The answer's, I think, almost none unless you get back to sort of a Japan interest rate scenario. I mean, that's what those interest rates derivatives were used to protect against. For instance, we have a lot of 10-year floors and stuff. So you probably won't see hardly any impact in earnings unless we have a severe interest rate scenario. Interest rates have obviously moved up since year end, so it's coming our way.

We will also probably, at the right time, we'll re-strike. We want to put on some new hedges. But we just felt here's all this value sitting in front of us and we think probably Treasuries are going to rise or going to decline in value or interest rates are going to go up. It'd be a real shame to let that just dissipate. Why don't we just take them off the table? And that's what we did.

Mark Finkelstein - Fox-Pitt Kelton

And then, Steve, a lot of discussion about the commercial real estate block or the commercial mortgage loan portfolio. Can you just provide some color on the fundamentals in the agricultural booking, thinking about performance, risks you're focused on, what is on your watch list, maybe just some color in that area since it does get a little bit less attention.

Steve Kandarian

Okay. First let me note that in general our ag mortgage portfolio has a lower loan-to-value than even our commercial mortgage portfolio. They tend to be very conservative loans; historically very low delinquencies or defaults or losses. The area we'll see some stress will be the biofuels sector. And we don't have a great deal of exposure there but we have some, and that's the area that we're watching most closely and if there is some stress we're most likely to see the stress in. But overall the portfolio still is very sound and very strong.

Mark Finkelstein - Fox-Pitt Kelton

And then I guess just finally, you talked about stressing the commercial mortgage loans and I think you said you looked at it on a 40% decline in kind of what the result in average LTVs were. Are there any metrics that you can give us in terms of kind of what percentage falls above a certain LTV range? Maybe it's 85% after you do that stress test. Are there any kind of metrics to kind of look at what would be perceived as the more risky areas?

Steve Kandarian

I'm not sure I have that number right with me, but the stress test, we took things down 40% from the peak just to kind of review that means. That's really taking a look at 2003s or the beginning of the uptick. And if you take 100, for example, and take it up 40 to 140 and you take it down 40%, that takes you down to 84, which means 16%, the low where you started from.

So under that extreme scenario, I gave you the numbers, about, you know, low to mid 70s overall, but obviously there'll be some above the 85% range. And we've done that stress testing and had the numbers, but I just didn't bring that with me.

Conor Murphy

Okay, Julie, thank you.

Operator

Thank you, ladies and gentlemen. This conference will be available for replay after 10:00 a.m. today through midnight, May 8, 2009. You may access the AT&T teleconference replay system at anytime by dialing 1-800-475-6701 and entering the access code 994685. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844 and enter the access code 994685.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: MetLife, Inc. Q1 2009 Earnings Call Transcript
This Transcript
All Transcripts