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

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

Bill Mullaney – President, Institutional Business

Bill Toppeta – President, International

Analysts

Jimmy Bhullar - J.P. Morgan

Nigel Dally – Morgan Stanley

Suneet Kamath - Sanford Bernstein

John Nadel - Sterne, Agee & Leach

Ed Spehar – Bank of America/Merrill Lynch

Colin Devine - Citigroup

Mark Finkelstein - Fox-Pitt Kelton

MetLife, Inc. (MET) Q2 2009 Earnings Call July 31, 2009 8:00 AM ET

Operator

Welcome to MetLife second 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. Good morning, everyone. Welcome to MetLife's second quarter 2009 earnings call. We are delighted to be here this morning to talk to you about our results for the quarter. We will be discussing certain financial measures not based on generally accepted accounting principles, 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 Bill Mullaney, President of our U.S. Businesses and William Toppeta, President of International as well as other members of management.

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

Rob Henrikson

Thank you Conor. Good morning everyone. During the second quarter MetLife generated very strong top line results. Premiums fees and other revenues increased to $8.4 billion which by the way is one of our highest quarters ever. Our operational earnings increased significantly over the first quarter earning $0.88 per share. Book value including AOCI improved by approximately 18% from the first quarter.

It is evident that our diverse mix of businesses and solid fundamentals have allowed us to perform well and continue to grow in this challenging environment. We are still experiencing a flight to MetLife and increased market share in many of our key businesses while importantly maintaining our pricing discipline.

Before I share our business highlights I would like to talk briefly about our recent decision to combine our Institutional, Individual and Auto and Home businesses into an integrated U.S. business organization. We have an incredible opportunity to leverage our capabilities and further drive growth as we enhance our product design and distribution and streamline our decision making process. This is an exciting time for our company as we build upon our strengths and seize opportunities in the market place.

This realignment was a significant outcome of our strategic review we have been telling you about since last summer. Another element of our strategy which we have discussed before is operational excellence. We are well on our way to achieving the significant cost savings we have targeted under this initiative.

Now let me provide some insight into the performance of our businesses. The Institutional business generated outstanding results as the top line grew 8% year-over-year to $4.3 billion. Our Group Life premiums fees and other revenues grew over 4%. Our non-medical health grew by 3%. Retirement and savings business grew 35%. We had higher close out sales, particularly in the U.K. where the market is improving. We also experienced a significant increase in structured settlement sales as we grew market share in this business.

Our Group Life and Disability Underwriting results were strong, though dental performance was disappointing with higher benefit utilization as a result of the ongoing economic uncertainty. Individual business after two challenging quarters generated some very positive results during the second quarter. Life sales were strong across all channels, up 27% sequentially though down 9% year-over-year. Annuity deposits increased year-over-year by 43% with a record $4.5 billion in variable annuity deposits and nearly $1 billion in fixed annuity deposits.

Annuity net flows on both fixed and variable annuities remained positive, $3 billion in total, and both are benefiting from declining lapse rates for the second consecutive quarter. In International, premiums fees and other revenues declined over the year-ago period due to the strength of the U.S. dollar though on a constant currency basis top line revenue was flat. In Latin America premiums fees and other revenues were down 6% on a constant currency basis.

We continued to have solid performance in the Asia Pacific and European regions. In Asia our premiums fees and other revenues were up 8% on a constant currency basis. In Japan there has been significant growth of fixed annuity deposits while variable annuity deposits have declined, reflecting a continuing shift in that market place. Our European premiums fees and other revenues were up 7% on a constant currency basis as our European region businesses continue to grow. Auto and Home had another strong quarter delivering earnings of $76 million, up 46% over the second quarter of 2008.

Now I would like to shift gears for a moment and talk to you about our capital strength and some related events in the quarter. Over the past several months I have been telling our clients, our shareholders and all of you that MetLife’s strong excess capital position, ample liquidity and leading market position set us apart in the life insurance industry.

As you know, MetLife participated in the Government stress test. We believe the assessment reinforces what we have said about our strong capital position. Let me just mention a couple of points. On the measure of total potential losses ours was the lowest of the 19 participants. Furthermore, the potential losses on our commercial real estate loan portfolio were also lowest at 2.1%, a fraction of the median at 10.6%. I point this out because commercial real estate mortgages continue to be a topic of discussion and we believe the stress test assessment supports our view that our underwriting differentiates us from other financial institutions.

On the measure of tier one common capital adequacy we were fifth strongest and remember we were also the only company of the 19 that did not participate in the TARP capital purchase program. Also in the second quarter we took the opportunity to further bolster our capital and issued an additional 1.25 billion in debt which was several times over-subscribed. All told, we continue to be confident that we have the financial strength to succeed now and over the long-term.

Looking forward, we will continue to leverage opportunities to build even a stronger company. We are proud of our initiatives to offer simpler, better products to our customers as they continue to seek trusted companies and quality products. For example, we recently launched our Simple Solutions variable annuity which offers easier to understand and lower cost benefits especially to those nearing or in retirement. These are being offered in banks, providing a new vehicle for financial advisers to help clients turn retirement assets into a stream of withdrawals they cannot outlive.

We have also commenced a co-branding pilot program with other major global financial firms. These efforts, among others, will allow us to maintain our leading market position as we continue to benefit from a flight to quality and increased market share. In summary, despite the uncertain environment MetLife’s businesses are performing well and with the recent realignment we are even better positioned to meet the needs of our clients and we have the capacity and financial strength to further solidify our leading position in the industry.

With that I will turn it over to Steve.

Steve Kandarian

Thanks Rob. I would like to spend a few minutes reviewing the key components of our investment results for the quarter. First let me start with a comment on variable investment income. Pre-tax variable income for the second quarter was zero which was below plan by $150 million or $102 million after tax and DAC primarily driven by negative real estate fund and corporate joint venture returns.

Real estate fund returns were negative due to the continued decline in property valuations. We estimate that property values have declined an additional 5-10% during the second quarter with an expected peak to trough total decline of about 40%. While corporate joint venture returns improved substantially from the first quarter they still remained negative during the second quarter.

On the other hand, income from our securities lending program continued to outperform plan. In addition, hedge fund returns continued to improve and were above plan during the quarter. However, we expect variable income will remain below plan for the remainder of the year.

Now let me cover investment losses for the quarter. Gross investment losses were $546 million, in line with the previous four quarters. Write down’s this quarter were $846 million. These write down’s were experienced across a variety of sectors including $248 million in corporate credit, $129 million due to the strengthening of the mortgage valuation allowance and $82 million in structured finance securities. Write down’s also included $325 million of partnerships and equity securities and $62 million of hybrid securities which were impaired because the length of time and the extent to which the market value had been below amortized costs.

Losses due to derivatives that do not qualify for hedge accounting were $2.8 billion. This was primarily attributable to a $1.5 billion pre-tax loss due to the improvement in MetLife’s own credit spread and its impact on the valuation of certain insurance liabilities. For example, MetLife’s five year credit spread decreased 312 basis points. This reverses derivative gains in previous quarters that occurred when our credit spread widened. The remaining $1.3 billion loss was due to several factors that negatively impacted the valuation of our derivatives including higher Treasury yields which reduced the value of our interest rate swaps and floors, the weakening of the U.S. dollar which reduced the value of our foreign currency swaps used to hedge foreign denominated assets and the declining credit spreads which decreased the value of credit default protection we purchased for our corporate bond portfolio.

As I have discussed previously, while the decline in the value of these derivatives is reflected in our income statement, it is generally offset by a change in value of the hedged assets or liabilities. Gross unrealized losses for fixed maturities were $19.5 billion at June 30, down substantially from the $28.8 billion at March 31 as spreads declined across all sectors.

Next I would like to discuss our real estate related holdings. As of June 30 we held $41.8 billion of residential mortgage backed securities including $7.3 billion of non-agency prime and $3.4 billion of alt-a mortgage backed securities. As I discussed in the last earnings call, the ratings agencies have downgraded virtually all 2006 and 2007 vintage alt-a securities to below investment grade. As a result, 88% of our 2006 and 2007 vintage alt-a securities and 56% of our total alt-a portfolio is rated below investment grade at quarter end.

In addition, during the second quarter the ratings agencies downgraded non-agency prime securities. As a result, 32% of our non-agency prime holdings are now rated below investment grade. The remaining $31.1 billion of residential mortgage backed securities are AAA rated agency backed securities.

As noted on several occasions, we believe our non-agency RMBS portfolio has superior structure to the overall market. For example, 86% of our alt-a and 97% of our non-agency prime securities are fixed rate versus 35% and 51% for the market respectively. In addition, 90% of our alt-a and 51% of our non-agency holdings have super senior credit enhancement. Furthermore we hold no Option ARM mortgages as compared to the 29% for the alt-a market place.

At quarter end MetLife’s commercial mortgage portfolio was $35 billion. As of June 30, the portfolio loan to value increased to 63% based on our rolling, four quarter property valuation process or we estimate in the mid to high 60% range if all properties were revalued today. In addition, the debt service coverage ratio for the portfolio is a very healthy two times. Moreover, commercial mortgage delinquencies and losses remain minimal. We had no defaults in our U.S. portfolio during the second quarter and only one small default in our international portfolio in the amount of $6 million.

As I mentioned earlier we have strengthened our mortgage valuation allowance resulting in a commercial mortgage reserve of $435 million at June 30, up from $329 million at March 31. In addition, only $1.6 billion of the portfolio matures during the remainder of 2009 and $2.5 billion in 2010. We remain comfortable with this level of roll over and expect to refinance as a whole the vast majority of these mortgages as we refinance them at market rates.

Finally let me say a few words on our cash and short term holdings. As of June 30 our cash and short-term investments were $21.3 billion, down from $30.3 billion as of March 31. Over the course of the quarter we invested in a diversified portfolio of assets primarily including U.S. government securities, agency residential mortgage backed securities and investment grade corporate credit. The yield on these purchases, excluding the U.S. government securities and floating rate securities was approximately 5.65%.

In conclusion, while we have seen some stabilization in the financial markets we remain defensively positioned and are cautiously reinvesting our liquid assets. With that I will turn the call over to Bill Wheeler.

Bill Wheeler

Thanks Steve and good morning everybody. MetLife reported $0.88 of operating earnings per share for the second quarter. This morning I will walk through our financial results and point out some highlights as well as some of the unusual items which occurred during the quarter.

We had premiums fees and other revenues of $8.4 billion. This represents an increase of 3.5% as compared to the second quarter of 2008. Adjusting for the impact of exchange rates had on international’s reported revenues, MetLife’s premiums fees and other revenues would have been up by 6.2% as compared to the second quarter of 2008. I think that is an excellent result in this environment.

Institutional’s revenues were up 8% as compared to the second quarter of last year. This was primarily due to strong U.K. pension close out and structured settlement sales. Group life grew 4.1% and non-medical health grew at 2.9% as compared to the second quarter of last year. International had reported revenues of $1 billion in the second 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 would have actually been flat with the second quarter of last year.

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 91.3% was well within our guidance range of 91-95% and flat with the prior year. In non-medical health and other, group disability morbidity ratio of 87.6% for the quarter was better than our target range of 89-94% driven by continued stable incidents. We saw higher claims utilization in dental but that was largely offset by favorable results in other non-medical health products.

Individual’s mortality ratio of 74.9% is significantly more favorable than our plan, driven by lower claim frequency. Individual’s underwriting results were favorable this quarter across all life products. Turning to Auto and Home the combined ratio including catastrophes was 93.5% down from the 99.5% experienced in the second quarter of 2008 due to lower catastrophes in the current quarter. Included in this result is a non-cash prior accident year reserve release of $3 million after tax compared to a $26 million after-tax release in the same period of last year.

Moving to investment spreads, with regard to variable investment income as Steve just explained, we again saw mixed performance of certain variable alternative asset classes this quarter. We experienced negative returns in real estate funded corporate joint ventures. Securities lending margins were strong and hedge funds performed well with returns on both asset classes coming in above plan. For the quarter variable investment income after tax and the impact of deferred acquisition costs was $102 million or $0.12 per share lower than the 2009 plan.

Moving to expenses, our overall expense level was higher this quarter but that was driven by higher pension and post retirement benefit costs. Pension and PRB expenses were approximately $100 million pre-tax higher than in the second quarter of 2008. As I mentioned last quarter we expect our pension and post retirement benefit costs to increase by approximately $300 million in 2009 mainly due to weaker investment results.

Also in this quarter we incurred $33 million pre-tax in operational excellence charges which consist mainly of severance payments and some consulting payments. Our operational excellence initiative is progressing well. Related expense reductions were approximately $75 million in the second quarter which annualized to a current run rate savings of $300 million.

Finally, also in the expense line the equity market improvement of over 15% and interest rate movements in the second quarter increased earnings through lower back amortization in individual business by approximately $58 million after-tax or $0.07 per share.

Turning to our bottom line results, we earned $723 million in operating income or $0.88 per share. With regard to net investment gains and losses, in the second quarter we had net investment losses of $2.6 billion after tax. Our derivative losses were $1.8 billion after-tax and as Steve mentioned the largest portion of that result was a $1 billion loss after tax by the tightening of MetLife’s own credit spread.

Our preliminary statutory operating earnings for the second quarter of 2009 are approximately $1.1 billion which is very good and our preliminary statutory net income is $530 million. Our results this quarter include the adoption of a new FASB pronouncement for the recognition of other than temporary impairments of debt securities. This is FAS 115. Under this guidance, the credit loss or the portion of the decline in value that represents the reduction of expected cash flows is included as a charge to net income while the remainder of the decline in value or the non-credit portion is recognized within accumulated other comprehensive income (AOCI). As a result of the transition adjustment required by the guidance, equity as of April 1 was increased by $76 million after tax and DAC with a corresponding reduction due AOCI.

This transition adjustment represented the non-credit portion of previously reported other than temporary impairments on debt securities. For the second quarter of 2009 the other than temporary impairments of debt securities in total were $566 million on a pre-tax basis of which $332 million was included in realized investment losses while the remaining $234 million was recorded in other comprehensive income. So again the FAS 115 adjustment would have been $234 million.

In summary, the fundamentals of our business continue to prove strong and we continue to succeed in this challenging market environment.

With that let’s turn it over to the operator so we can take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jimmy Bhullar - J.P. Morgan.

Jimmy Bhullar - J.P. Morgan

First, on your cash balances they went down $9 billion from the first quarter’s $21.3 billion. I just wanted to get an idea on where you think normal cash balances will be a year or two years down the road and how fast do you expect to get there? The second question is on your variable investment income. I think Steve mentioned it is unlikely to be below the $150 million run rate or the guidance for the year but versus the quarter you just reported how should it improve? What are the asset classes that could get better or what could get worse whether hedge funds or real estate? Finally, on your derivatives losses if you could give us an idea on how much you have left in derivatives gains that could reverse over time if spreads were to go back to let’s say where they were a year ago? How should we think about that number repeating in the third quarter again?

Steve Kandarian

I will take the first two questions you posed. The cash balances are likely to drift down lower over time. I don’t have an exact number or projection for you. It really is something we look at very closely with current market conditions. Obviously with all of the changing dynamics in the market place it is very hard to predict this. So, as you know we have been very cautious. We stayed liquid in the first part of the year here beyond what we would normally do. We have sort of gone back into the credit markets gradually over the last few months. So I don’t have an exact number for you but we certainly are reinvesting now in more normal array of assets compared to earlier in the year and late last year.

Regarding the variable investment income, I think there are some pluses and minuses likely to occur here over the course of the year. That really is a guess because it is very hard to predict what is happening or what is going to happen in the credit markets and the financial markets in general. For example, if the stock market continues to perform reasonably well through the remainder of the year we would expect our hedge fund returns would remain fairly strong which they were in the second quarter compared to the two quarters previously.

Private equity funds in that kind of environment would probably be going sideways pretty much. I don’t see a lot of big realizations in this market place in the near-term. At least we wouldn’t see as many write down’s as we saw in the previous couple of quarters; Q4 of 2008 and the first quarter of 2009. We do think that the real estate fund area is likely to remain weak. It tends to be more of a lagging indicator than some other sectors so we anticipate that sector to be weak for the remainder of the year.

Again, all those comments are caveated based upon what happens in the markets in general. If we see a real rally in the markets even beyond what we have seen to date then those numbers will improve. If we see the market sell off dramatically then obviously the numbers will come down pretty sharply as well. Lastly what I would mention is our securities lending program is currently about $22 billion at quarter end, up from about $20 billion the previous quarter. With a relatively steep yield curve it is a fairly attractive business once again for us. The profits there are strong. Obviously the balances are far less than they were at one time when we saw balances in the mid $40 billion range, actually peaking at about $50 billion.

We don’t see those kinds of balances any time in the foreseeable future.

Bill Wheeler

With regard to derivatives I’m going to answer your question this way. If you look back at our derivatives gains and losses let’s say since the beginning of 2008 we on a net basis have derivative gains. Just two quarters ago, obviously we had a very big derivative loss this quarter, but two quarters ago we had an equally big derivative gain. Now obviously a lot of that is driven by on credit which is not cash and obviously it is really sort of accounting noise if I am allowed to say that. It doesn’t affect capital or anything.

The other derivative gains there might be a cash settlement component to it. So if you look over the last six quarters we really had derivative gains. Another way to think about this is in our cash balance that Steve talked about, the $21.3 billion this quarter, in that there is about $3 billion related to collateral mainly on the settlement of derivative contracts so we are still way in the money on a lot of our derivative positions.

So there is room. Of course, remember and keep this in mind, derivatives are hedging something. If derivatives keep going down some other part of our balance sheet is improving, probably AOCI, probably the bond portfolio but sometimes it is liabilities so that is something we feel good about.

Jimmy Bhullar - J.P. Morgan

Could you just give us a number on your stat income, if you have an estimate for the second quarter?

Bill Wheeler

It was in my remarks. Our stat net income was $530 million which is an estimate still. It is not final. Our stat operating income was $1.1 billion which is quite good.

Operator

The next question comes from the line of Nigel Dally – Morgan Stanley.

Nigel Dally – Morgan Stanley

In the past you have talked about the potential EPS power of the company being in the range of $4.25 to $5.00 but with the caveat that it would take time and perhaps significant time with respect to alternative investments to return to that level. Any change in your view of that longer term EPS potential following these results? Secondly, Steve with realized investment losses earlier in the year you talked about potential losses of 1% of general account assets. The results in the first half of the year are certainly consistent with that. Is that still a good number for the back half of the year and any reviews for 2010?

Bill Wheeler

I will certainly give you my opinion about the variable investment but probably Steve is the right person to talk to. I think it should recover next quarter. But Steve might be a little more cautious than that. I’ll let him comment on that.

Steve Kandarian

On the losses for the remainder of the year, again as I mentioned under variable income it is really hard to project when you don’t really know quite what this market is going to be doing quarter-to-quarter, month-to-month or even day-to-day. The 1% number we have used I think is a pretty good guide for our estimate for the remainder of 2009. I think it is still in the early days to say too much about 2010 but we will certainly talk about that at Investor Day. So much of this depends on the overall economy, consumer sentiment, policies in Washington, impacts upon markets, psychology of markets and so on. It is very difficult to predict. I think we can say that the 1% number that we have used, Bill and myself, in the past is a pretty good guide here.

Bill Wheeler

Maybe I misunderstood your question a little bit. I don’t think actually in terms of that little public exercise we went through about foreign [inaudible], that sort of assumes that eventually VII is going to recover which we obviously think it will and then eventually we will get fully invested and we will invest in spread assets. The timing of that, I think as I said then and I would still say, as you just heard Steve repeat, I think the timing is we will have to see. The momentum is going the right way but we will have to see about how quickly we do that.

Nigel Dally – Morgan Stanley

If I could just follow-up on the investment portfolios. Below investment grade holdings continue to see some adverse ratings migration. What is the risk if you continue to face adverse ratings migration going forward that some of those assets will not be able to be admittable for statutory purposes pressuring your capital?

Bill Wheeler

I think we are far below any kind of limitations there with regard to the ratings migration. I am kind of hoping. Maybe it is just wishful thinking that the ratings migration may be over but maybe not. We will find out. I think obviously just the mere fact there is a ratings migration creates a capital charge. The way to think about that or the way I encourage people to think about that including our colleagues in the rating agencies is obviously by downgrading a bunch of securities that we thought we were investing in at AAA they have caused a capital drag. But it is temporary. Eventually we will work our way through that. It will take a couple of years. In our case, of course, as Steve just talked about, we think the securities are money good. But it is a capital tax they have created if you will. We will work our way through it.

In terms of whether or not we are up against any statutory limitation I don’t think we are very close.

Operator

The next question comes from the line of Suneet Kamath - Sanford Bernstein.

Suneet Kamath - Sanford Bernstein

On the variable annuity business obviously your results there are some of the strongest we have seen so far in the quarter. I just want to talk a little bit about risk management. I think in the past you have said that one of the reasons you like the VA business is you have all these other businesses that form this diversification. How do you think about how much capacity you have to write new VA business? It just seems like you can kind of write as much as you want in this environment given your market share. How should we think about that? The second question is a numbers question on the capital. Bill you provided the stat numbers in terms of earnings but do you have an RBC estimate as of the second quarter and then is the $5 billion of excess capital you have talked about in the past still a good number to use?

Rob Henrikson

Let me start off by saying, and I know you would understand this but just so everyone understands, I do love the variable annuity business. It is something that is easier to love if you are well diversified and have multiple sources of earnings and you can spread your risk. However, I would say as a caveat there that is under the assumption you are properly designing and pricing your products in the variable annuity business. The way you phrased the question I just want to make sure that people didn’t think that I was ever saying that because we are in other businesses we can have one that we don’t pay attention to because we are very comfortable with the way we manage our variable annuity business.

I am happy with obviously our increased market share. It is very unusual to see your market share double in a period of a couple of quarters. Whether or not we can maintain that market share will be dependent on what happens to others in the market and so forth. Am I comfortable with the market share we have? Yes. I don’t know it would be wise to predict you would continue to hold a market share of 17-18%. I think that is to be determined.

Bill might want to add more specifics.

Bill Wheeler

Obviously in terms of just a risk management point of view we want diversification in how we make money. We make a lot of money. Obviously the VA business has a lot of earnings power and a lot of earnings potential to it. My feeling is that is probably all the equity exposure we want. But we will see. With regard to RBC, I think just for everybody’s benefit, we don’t calculate the RBC every quarter. It is only done once a year. The reason for that is it is actually a very complicated calculation. There is lots of [stochastic] modeling which gets done. We do not do that every quarter. I don’t want to pretend like we don’t think about RBC every quarter because we obviously do and we do some short hand calculations to make sure we have a good sense of what is going on with our capital ratios but it is not a number I think is ready for prime time. We won’t disclose an interim estimate number because that is not something I am frankly comfortable with.

The capital levels, there is a lot of tension in what’s going on with capital right now. You have got rating securities migration which is obviously a drag. We just talked about that. You have got state regulatory relief which is up in the air about which we had some state relief for sub-par in some states, not New York frankly, that happened this year and who knows what will happen later in the year when that stuff has to get renewed. You have got an environment which frankly is much better than it was at year end in terms of where the stock market is and where interest rates are and that helps your [stochastic] modeling frankly, your [C32] calculations and such.

So in general I feel like our RBC ratio has probably come down from year-end probably driven really from credit migration but frankly the earnings that we had this quarter were quite good. The same thing you should remember is what is not included in any of those calculations is the $5.2 billion of cash that is sitting at our holding company right now. So I feel like it is hard for me to be real precise about what an excess capital number is but I think we still have quite a bit of excess capital and I think we are frankly, I know we all feel better now maybe than we did a couple of months ago, but I think we have plenty of capital to kind of meet any challenges which we think might be coming up over the next period of time.

That probably is about as strong an answer as I can give you.

Suneet Kamath - Sanford Bernstein

When you used to talk about the $5 billion of excess capital last quarter did that include any of that cash at the holding company? If so, how much?

Bill Wheeler

It did. It would have included all of it except we have a rule of thumb that we want to have $750 million of cash at the holding company at all times so I don’t call that excess. So it would be anything north of that. We have added to the cash pile since March 31. Rob referenced the debt deal we did in the second quarter for $1.25 billion. We also did a hybrid deal right at quarter end. I think it actually technically closed right after the quarter for $500 million. We obviously burned a little cash from interest payments and stuff like that at the holding company. There is more cash at the holding company but there is probably also a lower RBC ratio because of continued credit migration.

Operator

The next question comes from the line of John Nadel - Sterne, Agee & Leach.

John Nadel - Sterne, Agee & Leach

Rob, I was hoping you could give us a little more color on the rationale for the organizational changes. Maybe specifically I think there have been some in sort of the outside investor community who might believe we should read something into that about positioning the company organizationally for some M&A. Any comments there?

Rob Henrikson

Actually the organizational realignment had nothing to do with M&A whatsoever. Remember, it was the outgrowth of our strategic initiative that we have been focused on for the last couple of years. The purpose of the reorganization, if you look at it from the standpoint of you may recall I talked about our focus was on decision making. That decision making and the streamlining of it has moved forward at just a wonderful pace. What you are seeing if you look at our businesses and the opportunities we have, that streamlined decision making gives us a better, quicker way to enhance product design and distribution. It give us better ways to recognize contingent space growth opportunities. It preserves the distribution channels we have that are so very important to us. We are very fortunate to have a very, very strong management team that this organizational team allows to lever up even greater. It has nothing to do with M&A at all. I would only say that to the point you have better streamlined decision making and better leverage of talent that would allow you to be clearer, smarter and more progressive in your thinking in everything you do including analyzing M&A opportunities.

John Nadel - Sterne, Agee & Leach

Bill, maybe going at Nigel’s question in a little bit different tact. Obviously operating earnings rebounded nicely from first quarter results but if we look at sort of the absolute level the ROE this quarter annualized was about 8%. I know there is some meaningful drag on that ROE, the higher cash balances, variable investment income and the like, but I would be interested in your thoughts assuming reasonable markets on how long it takes for that ROE to get back to sort of the low double digit range? Maybe with your existing business mix and again assuming reasonable markets, where can that ROE go longer term?

Bill Wheeler

It is certainly my expectation, and again with your caveat of reasonable markets, we are going to be within shouting distance of a 10% ROE next year. That is not assuming any dramatic recovery. That is just putting money to work and stuff like that. I think in terms of obviously I think it can improve from there. I think the tension, and I’m not sure how this will play out, to kind of get back to sort of I would say a mid-teen’s ROE in our industry you have to manage capital. [That means] just to buy back stock. Okay? That means you have to run a relatively efficient capital level. You don’t have to be real tight but you can’t just stock pile capital. You have to manage it. I don’t see how you really get to a 15% ROE, certainly some businesses can but given our current business mix I don’t see how you can get there without some capital management effort.

I would say this for Met but I would say this for the industry as well, I think it is going to be a number of years before we really start thinking about capital management again. It could be because we are going to want that capital for other purposes. Frankly given where our growth rate is right now we may need to deploy that capital just based on current internal growth. There is obviously maybe other opportunities to redeploy capital other than just buying back stock but you can’t count on that. I think we can continue to move the ROE up as the economy recovers. I feel pretty comfortable about that. Where we feel three years from now and the way to move it up further is really by driving more aggressive capital management. I think that is yet an open question.

John Nadel - Sterne, Agee & Leach

One quick follow-up on putting capital to work for Bill Mullaney, obviously a little a bit more activity here recently in the pension close out business. I am wondering what that business and the pipeline and activity especially relative to bigger transactions might look like?

Bill Mullaney

Let me just give you a little color on what we are seeing in close outs. Obviously we have two close out businesses, one here in the U.S. and one in the U.K. The U.K. business has actually been pretty active and we did a couple of sizeable deals this quarter. I would say within the U.K. they are even farther along than the U.S. in terms of thinking about close outs, positioning their portfolio for potential close outs, so I don’t think the portfolio got as hit when the equity markets declined. Remember, I think you have a better funding status in the U.K. So therefore, I have also seen some competitors pull back in the U.K. which I think has made it a better pricing environment for us so we are able to write some good deals at some attractive returns. We continue to have lots of discussions in the U.S. with plan sponsors who are thinking about close outs. I would say the decline in the equity markets has certainly made everybody realize what the impact of equity market volatility has on funding status. So I think as fundamentals recover there will be a great interest and demand in terms of moving some of those liabilities off the balance sheet.

As Bill talked about before, we do have excess capital and we are prepared to put that excess capital to work on some deals where we can get some attractive returns.

John Nadel - Sterne, Agee & Leach

As a follow-up, in terms of how much capital that business takes can you give us a sense like $100 million close out, how much capital needs to support that?

Bill Mullaney

It is really very much a function of the structure of the deal so if you have true non-par deals you might have a capital percentage that could be in the 10% range. If you had separate account deals or par deals the capital structure would require something less than that.

Operator

The next question comes from the line of Ed Spehar – Bank of America/Merrill Lynch.

Ed Spehar – Bank of America/Merrill Lynch

I wanted to go back to the ROE question and back to the presentation you had done on your earnings thought experiment. If we look at the second quarter of $0.88 I think that the amount you put back to work in terms of cash balances is roughly in line with what you had highlighted as the low end in that presentation. If we just assume that you only had half the benefit in the quarter maybe you got another $0.05 from what you did so we are up to say $0.93. I think you said you had $75 million of expense saves in the quarter so $300 million annual. Is that correct?

Bill Wheeler

That’s right.

Ed Spehar – Bank of America/Merrill Lynch

So we are right at the midpoint then in terms of the expense save number that you highlighted in that presentation as well. The only thing that isn’t there is variable income and conveniently it is zero this quarter versus the low to high that you modeled. I guess what I’m wondering is if you take that $0.93 and you annualize it you are at sort of a $3.70 to $3.75 number. What else can you do from that number to get the ROE up other than variable income and capital management?

Bill Wheeler

I think I would probably quibble with your ROE investing, have we already shot our wad if you will with regard to how much cash we have invested and how much more we have to go. We have made some progress in terms of reinvesting cash but we are a long ways from, you know if you just go back and look at our QFS four or five quarters ago we are running about a $10 billion cash balance a quarter. We are at $21 billion now and you can’t just say okay there is $11 billion excess there. It is not quite that simple. We have a long ways to go in terms of I think cash efficiency and then you heard Steve say in his remarks where he put most of the money this quarter was in Treasuries and agencies which is better than yielding and cash but hardly what I would call a full-spread asset. So I think there is opportunity there as well.

In terms of the recovery on VII, I don’t want to get too hung up on this because look it is not something we can control obviously. Private equities will come back when they come back. We have $8.3 billion in alternatives and we are not making much on that today at all. Even in the second quarter. I think there is a lot of power there over and above $0.88. So I don’t want to try to follow the math on the phone so maybe we can follow-up on the phone but I think there is a lot of earnings power that is sort of sitting there that is not really engaged yet.

Then of course we are growing the business at the same time. Oh yeah, we are doing that as well. I will tell you it is not just revenue growth. If anything the GAAP revenue growth probably understates how good this quarter was because a lot of the money is coming in as deposits. Then the margins that this stuff is getting put on is quite good. Then just to pile on a little more I don’t know if I quite followed all your expense math but I think maybe you got it right. I’m not sure. We are obviously not done in terms of expense improvement here. Operational excellence is obviously a nice kick. If our pension costs are really high, if we get any kind of rally in the equity markets that just starts to come down and unfortunately all the good work that we are doing in terms of OpEx are being masked by some unusually high pension and post retirement benefit costs. So probably the earnings kick there is probably even a little greater than maybe we have estimated before.

Ed Spehar – Bank of America/Merrill Lynch

Your comment about capital management being a number of years away, share buyback being a number of years away, perhaps for the industry and for you. Have you had any discussions or thought about the trade off in saying would it work if we kept $20 billion in cash balances and when the time was right we reduced the allocation to alternatives and as an offset would the rating agencies then be comfortable with whatever now is considered to be in excess of the appropriate amount of cushion and capital to knock that down? Can you tradeoff between the cash and investments and alternatives with the potential to buy back the stock sooner?

Bill Wheeler

That is an interesting question. I don’t know. I think what your question really highlights is all that stuff is very much in the air yet. I don’t think the industry or really the analysts who follow this industry are really settled, or the rating agency obviously too, are really settled on the way forward here. I think it could very well be at the end of the day we will learn to evaluate insurance companies by all the excess cash that is sitting in their holding company and they will view that as the excess capital component and then we will take that off the top and then think about ROE after that. That may be how things progress. We will see. I just think it just feels like it is a little soon to be putting out new aggressive ROE targets when I really don’t know if two years from now capital management is really going to be in the cards.

Operator

The next question comes from the line of Colin Devine – Citigroup.

Colin Devine - Citigroup

First, on variable annuities I appreciate the very strong sales. I was just wondering if you could give us a sense of what percentage of those are the GMIB products which I think Bill rescored last quarter you don’t do as much hedging because the gap volatility it creates. Also what percentage for 1035’s because it is certainly my sense the number for that industry has come way down and so we are actually seeing a lot of new customers come in? On the investment portfolio, I appreciate on page 40 you break out the quality by NEIC ratings but that is on a fair market value and I wanted to get a sense of how much jump on up sequentially in the quarter on an amortized basis, particularly as we look to that rapidly growing NEIC 5 category and what that may mean for losses over the second half of the year? Lastly, it is my recollection you had put on several billion of interest rate hedges and that you had planned to take them off in the second quarter. Where did they come through in earnings if that is correct? Lastly, what happened on the traditional life line?

Bill Mullaney

I will start on the VA question. I would say on our sales for GMIB this quarter about 85%. So it is pretty consistent with what we have seen in prior quarters. In terms of 1035 exchanges we don’t have that exact information but what I will say is we know the 1035 exchanges are down. We are seeing some benefit from 401K rollovers which is actually helping us from a sales perspective.

Steve Kandarian

On the downgrade, it is about $2 billion of downgrades on an amortized cost basis for the quarter.

Colin Devine - Citigroup

I’m actually trying to get a sense for if we look sequentially on an amortized cost basis what are your jumps on aggregate to at the end of the second quarter and what do they aggregate to at the end of the first? I have the fair market at 14.8 and 18.3 but amortized costs would be more helpful. That was up $2 billion? That is what you are saying?

Steve Kandarian

$2 billion was a number I was giving you about the downgrades.

Colin Devine - Citigroup

I was just trying to separate how much of the increase is just spreads tightening as to how much is what else is going on there?

Bill Wheeler

They are looking through a folder. While they do that let’s talk about interest rate derivatives. Actually I don’t think we are talking about the same thing. We said we took off some of our interest rate hedges that we have. By the way, these tend to be very long interest rate swaps or floors that are used to hedge certain liabilities. For instance, we have minimum interest rate guarantees. We hedge to protect ourselves against the Japan scenario. Interest rates dropped a ton right at the end of the fourth quarter so a lot of these hedges, these derivatives were way in the money and that gain, that derivative gain, shows up in our income statement in the fourth quarter.

What we did was we said certainly our feeling is interest rates are going to go back up. There is a ton of value here. Are we just going to let it slip through our hands and watch the hedge move against us? The answer is we chose to kind of split the difference and we took $1.5 billion of pre-tax gains off the table.

Colin Devine - Citigroup

Just to jump in for a second, so the mark to mark in losses we saw this quarter were net against those gains?

Bill Wheeler

Remember the mark to market occurs…

Colin Devine - Citigroup

I want to know where the gain is. How much was it and where is it?

Bill Wheeler

By the way we unwound the derivative and pocketed the cash. The gain occurred in the fourth quarter. We pocketed the cash in the first quarter. So if we hadn’t pocketed that cash our derivative loss, because obviously it was the right decision because interest rates moved back up and our derivative loss would have actually been greater. So most of that, not all of it, but most of that $1.5 billion of gain would have shown up as a higher derivative loss both in the first quarter and in this quarter.

Colin Devine - Citigroup

Okay, I thought you were taking some off in the second quarter from what you told us before.

Bill Wheeler

I think it was first. We did it. That was the easiest $1 billion we ever made. So I think it was a smart thing to do. I would say that is a highly unusual event for us and it is not something we would repeat on a normal basis.

Colin Devine - Citigroup

Then the traditional life line seemed to be unusually weak whether it was higher expenses or higher benefits. What was that?

Bill Mullaney

In terms of what was going on with trad life it really was driven by a couple of things. First of all we had a change in our DAC modeling so we took a pretty big charge for DAC in the first quarter on traditional life. We actually had a reverse on variable and universal life so you will actually see some of the gain show up there. Secondly, some of the earnings on the closed block going forward are going to be lower than what you have seen in the past because of some changes we have had to make in agreement with the state and the glide path around the earnings for the closed block. So those are really two reasons why trad life earnings were down over prior year.

Colin Devine - Citigroup

That is the first time I think we have seen a significant change to somebody’s DAC on traditional life. I know we are all getting tired of watching variable annuities going up and down. But it is a whole different matter on trad life. Was that just low interest rates that drove that?

Bill Mullaney

I’m going to ask Stan to talk some about the changes that we made around the DAC model.

Stanley Talbi

It had more to do with our closed blocks. We have a DAC model in our closed block that reflects expected gross profits. We had been negotiating at year-end with New York State on the operation of the closed block and our pattern of earnings was changing. Not in total, that doesn’t change. The assets are locked into the closed block. The future earnings are the same but the timing changed. We revised our model to reflect that change in the timing. So that resulted in a one-time DAC adjustment in the second quarter.

Colin Devine - Citigroup

Was that also persistency driven? I notice lapses are hitting your record.

Stanley Talbi

No it was not persistency driven at all.

Steve Kandarian

Let me get back to your question. The reason we are struggling a little bit is the spread tightening of the market value number basically and I know there was a bid value number so we are trying to make them all tie up. Roughly it is 50/50 of spread tightening increased that number and below investment grade and the rest was downgrades. There was a little bit of net selling in that category as well.

Operator

The final question will come from the line of Mark Finkelstein - Fox-Pitt Kelton.

Mark Finkelstein - Fox-Pitt Kelton

Firstly a clarification. Have you updated your estimate of expense saves based on some of the recent actions and if so what are they?

Bill Wheeler

For everybody’s benefit we put out a target on investor day, maybe a little earlier, $400 million of expense saves related to operational excellence and we said $400 million pre-tax related to operational excellence and by the end of 2010. There are obviously besides operational excellence obviously other things going on in the expenses so I gave you a little color on pension costs. Certainly the fact that the stock market rallies and therefore our pension costs go down next year has nothing to do with operational excellence. So we don’t try to take credit for that. So when we were throwing around a number like $600 it is stuff like that as well. The number that I quoted in my remarks that we had $75 million roughly of expense saves this quarter implying a $300 million run rate, that is keeping score on OpEx. So you can see we are close even though it is second quarter of 2009 we are relatively close or bearing down on our OpEx goal that we had for the end of 2010.

We are way early and things are going well. We have not updated our OpEx target number and I don’t expect to now and there is obviously a lot of momentum so stay tuned.

Rob Henrikson

If you were asking whether or not the recent organizational change was counted in our OpEx numbers it was not. The reasons is primarily the focus on the organizational change is one about growth and leveraging capabilities and market strength and so forth and so on. I can assure you, however, that will not cause the number to slow down in terms of our reaching our objectives. I just thought I would mention that. I couldn’t tell from your question whether or not that was embedded in your question.

Mark Finkelstein - Fox-Pitt Kelton

Yes that helps. On the VA sales in the quarter were those all off of the new pricing or were there still some lingering old prices that helped drive the sales growth?

Bill Mullaney

For the most part they were off the new pricing. We did some pricing changes in February and in May and we also made some product changes too and so while there may have been a little run up in sales prior to the pricing change we brought the guarantee on the GMIB down to 65. By and large it was done on the new pricing and for the most part on the new product.

Mark Finkelstein - Fox-Pitt Kelton

On the International business can you just talk quickly about Latin America? It looks like on a constant currency basis premium would have been down. I know that is kind of more Mexico driven but can you just talk about the dynamics in that and how we should think about that?

Bill Toppeta

I would say that Latin America is actually holding up pretty well in terms of the top line and the reasons why we have seen some downturn, first of all there is the FX question. The Mexican peso drives a lot of what we do and that has been weak compared to the U.S. dollar. Then we get to the substance of it. You have to remember that in the prior year we had the Argentina pension business which at the end of last year was seized by the Argentine government so all of that revenue obviously goes away. In Chile we are in the payout annuity business. That market has been down total market down about 34% during the quarter. What drives that really is that people’s accumulations that they would buy an annuity with are obviously down and they are very reluctant to buy annuities and lock in those losses. Now we are down a little more than the market. The market is down 34%. We are down 50%. Part of that is deliberate on our part. We have done some de-risking of our investment portfolio down there and therefore as a result of that we are not in a position to put out some rates that would enable greater sales.

So it is a combination I think of all those things. One last factor, relatively small but still had an impact, remember that Mexico is our big driver in terms of the top line and because of the H1N1 virus down there we pretty much lost I would say about a month out of the quarter. All of those things contributed to the results.

Conor Murphy

That finishes our call this morning.

Operator

Thank you. Ladies and gentlemen this conference will be available for replay after 10:00 a.m. ET today through midnight, August 7. You may access the replay service by dialing 800-475-6701 and entering the access code 105666. International participants may dial 320-365-3844 using the same access code 105666. Again ladies and gentlemen that does conclude our conference for today. Thank you for using AT&T Executive Teleconference Service. 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. Q2 2009 Earnings Call Transcript
This Transcript
All Transcripts