Nationwide Financial Services, Inc. Q4 2007 Earnings Call Transcript

Nationwide Financial Services, Inc. (NFS)

Q4 FY07 Earnings Call

February 08, 2008, 10:00 AM ET

Executives

Mark Barnett - VP, IR

Mark Thresher - President and COO, Nationwide Financial

Timothy Frommeyer - Sr. VP and CFO

John L. Carter - Sr. VP, Non-Affiliated Sales

Analysts

Tamara Kravec - Banc of America Securities

Thomas Gallagher - Credit Suisse

Darin Arita - Deutsche Bank

Mark Finkelstein - Fox-Pitt Kelton

Presentation

Operator

Good morning and welcome to the Nationwide Financial Services Fourth Quarter Earnings Conference Call. My name is Denise, and I will be your conference facilitator. All lines have been placed on mute to prevent background noise. A question-and-answer session will follow the speakers’ remarks. [Operator Instructions]. At this time I would like to introduce your host Mark Barnett, Vice President, Investor Relations.

Mark Barnett - Vice President, Investor Relations

All right, thank you Denise. Good morning and thank you for joining us on our fourth quarter 2007 conference call. Joining me on the call today is Mark Thresher, our President and Chief Operating Officer, who will provide his perspective on our performance during the quarter. Following his remarks, John Carter, President of our non-affiliated sales organization will discuss sales results, and then Tim Frommeyer our Chief Financial Officer will review the quarter's financial highlights and discuss our 2008 outlook. Then we will open the call for questions.

But first, I'd like to remind everyone that we are committed to transparency, including an open and candid dialog about our current operations and future prospects. Comments made during this conference call may incorporate certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This may include statements concerning such topics as sales and earnings growth goals, operational plans and other opportunities we pursue. Underpinning these forward-looking statements are certain risks and uncertainties. We refer our listeners to the safe Harbor disclosures contained in the fourth quarter earnings release and our latest SEC filings to appreciate those factors that may cause actual results to differ from those contemplated in such forward-looking statements. In addition, comments during this call will include certain non-GAAP financial measures governed by SEC Regulation G. For a reconciliation of these measures, please refer to exhibit 3 of our fourth quarter earnings press release.

Just as a heads up for your planning purposes, during 2008, our earnings releases and conference calls are tentatively scheduled toward the end of the first four weeks of the month following quarter end. And with that I will turn the call over to Mark Thresher.

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

Thanks, Mark. Good morning everyone and thanks for joining us. During my remarks, I will first comment on our financial results highlighting some of what we accomplished during 2007. Then I will spend a few minutes on our top priorities for 2008.

Let me start by saying that I am pleased with our overall performance during 2007. The fourth quarter capped a strong year of progress in our efforts to accelerate growth and improve returns for our shareholders. With a solid strategy and an unrelenting focus on execution, we're making the necessary changes to enhance our competitive position and support future growth. Moreover, our bottom line results reflect the strength and balance of our underlying business mix in the face of volatile markets in a challenging operating environment.

Turning to the numbers, fourth quarter net operating earnings were 162 million, or $1.16 per diluted share compared to 150 million or $1.00 per diluted share in the fourth quarter of last year. Earnings growth was primarily driven by increased asset base fees, increased contributions from our bank and mutual fund operations, as well as lower general operating expenses.

Excluding unusual items, all of our operating segments achieved improved profitability due to solid execution and disciplined expense management. Unusual items in the quarter negatively impacted results by about $0.03 per share, their details of which Tim will cover in a moment. So excluding the unusual items, our more normalized net operating earnings for the fourth quarter were about $1.19 per share.

Our reported return on equity for the fourth quarter was 12% and after adjusting for unusual items, we considered about 12.3% to be a more normalized ROE for the quarter. For the full year, our bottom line operating performance was also very solid. Full-year net operating earnings were $4.83 per diluted share, and excluding the impact of about $0.38 in unusual items from our 2007 results, net operating earnings per diluted share were $4.45. That compares to normalized 2006 net operating earnings of approximately $3.95 per diluted share, a good year no matter how you measure it.

Our full-year operating return on equity was 12.5%. Again excluding the unusual items, a more normalized ROE was about 11.7%, which is consistent with what where we expected to be relative to our past, or our 13% objective by the end of the 2009. Overall, our sales results during 2007 continued to improve, highlighted by an 18% year-over-year increase in VA sales, a 7% increase in retirement plans and improving momentum in our individual life sales.

Although private sector sales achieved record levels in 2007, the sales growth for the year was below planned levels, a disappointment in what otherwise was a very solid year. The weakness in fourth quarter sales was attributable to some changes we are making to improve the retirement plans business model, I will touch on the subject in a minute.

Total customer funds manager and administered ended the year at 162 billion. Net flows for the quarter were significantly lower than last year, due to several factors including two large corporate and bank owned life insurance deposits in the fourth quarter of 2006, and lower net flows in an investment-only contract in public sector retirement plans.

With respect to annuity flows, as we indicated in our last call, we believe that the fixed annuity outflows peaked in the third quarter of 2007 and as expected we saw a decline in fixed annuity outflows during the fourth quarter. We also saw a sequential decline in invariable annuity outflows and we believe we are in good shape to see positive variable annuity flows for the full year of 2008.

We continually look for opportunities to drive operating efficiencies and lower cost. For the full-year our operating segments generally achieved their expense targets enabling us to hold core-operating expenses at about our 2006 levels, which in turn helped the bottom line. On the capital management front, we took significant actions during 2007, deploying almost $1 billion in excess capital to the acquisition of the Nationwide Credit Union, the Nationwide Funds Group, as well as returning over $650 million to shareholders through dividends and share-repurchase. So, all in, I am pleased with our results in 2007.

We are overcoming the issues that hampered performance and we are driving improvement in our run rate results. We also continue to make progress on our longer-term financial targets as reflected in our 2008 operating plan, which targets improving assets, revenue, and earnings growth, as well as moving us towards our stated 2009 ROE goal of 13%. Part of what is giving me confidence in our outlook is that we are generally executing well and delivering on our strategic objectives.

On the product front, I think it is fair to say that we have regained our position as a product-related across key product categories. Our speed to market has improved significantly and we are now much better responding to changing market conditions. Another key area of focus for us during 2007 was improving the performance of our individual protection business. Over the last several quarters, we strengthened the competitiveness of our individual life product portfolio, we expanded our distribution, and Mike Hamilton and his team have restructured Nationwide Financial Network, but we still have more work to do. We are very encouraged by the improving sales momentum over the last two quarters in the nonaffiliated channel as well as NFN, including our property and casualty exclusive agents.

To improve individual protection segment returns, we are taking actions to free up under performing capital. During the fourth quarter, we committed to the planned sale of our interest in COLI distribution business and therefore moved operating results to discontinued operations and wrote down the value of related goodwill. Additionally, we are diligently working to put an AXXX external financing structure in place, which again will free up capital from redundant reserves and help improve the segment returns.

As you know, we're in a highly competitive industry. Winning over the long term requires scale combined with successful differentiation in the marketplace. As we view the landscape, there are many factors that are changing how financial services products are distributed. Client firms are becoming more selective in seeking manufacturing partners that can help them achieve broader firm objectives rather than more products centric goals. In that light, we believe our ability to bring a combination of investment protection and retirement plan solutions and services to our clients is significant, but an underutilized aspect of our business, and we can take advantage of in a much more meaningful way.

To better position ourselves to accelerate top line growth and realize cross-business synergies, we need to apply a more unifying approach to how we think about and how we manage our businesses. To further enhance our competitiveness, it is imperative that we shift our organizational focus towards leveraging the collective scale and unique value proposition inherent in our business to facilitate a superior means of bringing innovative financial solutions to the market. Accordingly, one of our primary focuses during 2008 will be to better align our business model to more effectively seize this opportunity. We will do this by aligning our organization to more effectively identify and serve customer needs.

To that end, we are working diligently to shift away from a siloed, product centric organization to one that truly understands consumers, client firms and investment professionals. We're using the knowledge we're gaining about consumers and advisors to develop comprehensive financial solutions rather than just individual products, which is consistent with our commitment to simpler solutions. Through better alignment and simpler solutions, I'm confident we can strengthen our competitive position. It allows us to more fully leverage the power of one nationally recognized and trusted brand, it facilitates the integration of packet solutions, including guarantees across product lines and it provides economies of scale through more integrated, marketing, products support and technology.

And at the end of the day, this will allow us to more effectively function as a strategic partner with client firms by providing what they really need, an easier way to meet the complete needs of the end customer. In fact, the potential impact that better alignment can have on our performance is seen by the focused firm distribution strategy and enhanced sale process that John Carter has been talking about for the last year. As we have discussed, we credit the focused distribution strategy for the increased effectiveness of our nonaffiliated distribution and is a significant catalyst of improved individual product sales performance. That task now is to leverage the success and focus more enterprise resources toward capturing synergies and building a superior means of bringing innovative financial solutions to the market.

Our retirement plans business is also a good example to how better alignment can improve our competitive position. Historically, our public sector 457 business and our private sector 401K business has operated independently with separate management, distribution, call centers and administrative systems. While that business model has been very effective for us, the market is changing and so we have to change too. Accordingly our priority focus for retirement plans during 2008 is to further accelerate the realization of operational efficiencies between our public and private sector business. This will be a longer-term effort, but we must quickly move to vertically integrate both upstream in areas such as record keeping and downstream such as the integration Nationwide branded mutual funds in order to achieve economies of scale, ensure price competitiveness, and more directly influence the customers’ experience. And one significant change has a potential to pressure short-term performance as we saw on the fourth quarter, I'm confident that this is the right direction for this business and it will make us a much stronger competitor over the long-term.

Before leaving this topic, let me say that a key aspect of our evolving business model is reflected in the investment we're making in our brand, which is a critical competent of strengthening our market position. Brand recognition and trust in brand are key attributes for both investment professionals and consumers in choosing financial services products. And we think this will be even more important as we go-forward. The success of the Life Comes At You Fast campaign at raising consumer and advisor brand awareness has been outstanding. Building our that success during 2008, we're focusing more advertising dollars directly on producers through significant ad placements in major financial publications such as The Wall Street Journal and Barron’s.

So, let me wrap. While the turmoil in the capital markets and the threat of recession is creating a lot of headwind, I think from a fundamental business prospective, NFS is well-positioned for growth. I'm optimistic that enhancements to our operations combined with the addition of higher return businesses, disciplined expense management, and an increasingly more efficient capital structure will result in further progress toward achieving our long-term financial targets. I also want to take just a moment to personally thank all of the associates across Nationwide Financial for your dedication, support and hard work during 2007. Your contributions have been critical to our success.

Let me now turn it over to John to review our overall sales results.

John L. Carter - Senior Vice President, Non-Affiliated Sales

Thanks, Mark, and good morning. Sales in the fourth quarter reflected a solid finish for the year. Our strategy to improve the sales process and to focus on key distribution partners is producing results and providing the foundation for sustainable long-term sales growth. As I mentioned on previous calls, we have also improved the competitiveness of our products across all of our segments to better serve our focus firms. Notably, we have achieved stronger growth across our primary non-affiliated channels with over 70% of non-affiliated sales coming from our focus firm partners.

The fourth quarter also produced strong individual protection sales and a meaningful improvement in Nationwide Financial Network productivity. Fourth quarter variable annuity sales remained strong. VA sales of 1.6 billion were up 16% over last year and 13% over the prior quarter. In light of the volatility exhibited in the equity markets during the quarter, we’re pleased with our results.

While Tim will talk about our outlook for 2008, let me briefly comment on what we are currently seeing in a variable annuity market. As you know, historically, industry sales of variable annuity products have tended to slow in times of market distress. With the threat of recession and market turbulence we’ve experienced in last few weeks, consumers as well as advisors appear to be retreating to the sidelines. We have seen some softening in sales during January. While this kind of market certainly highlights the advantageous of living benefit guarantees, it may take time for participants to overcome their fear and seek the protection afforded by these products. That said, the need for living benefit is stronger now than it's ever been and we continue to improve on our annuity portfolio.

We recently expanded our annuity line up to include a low-cost product called marketFLEX Advisor annuity designed for fee-based investment professionals. Attractively priced for these advisors, marketFLEX Advisor Annuity provides portfolio diversification using alternative asset classes and investment strategies without surrender charges. This allows investment professionals the ability to actively manage client portfolios and appropriately adapt to changing markets, as their wealth management strategy to minimize investment and market risk.

We also upgraded our Linc, Lifetime Income Rider to increase the rollup percentage from 5% to 7%. The higher rollup increases the value proposition to the consumer and at the same time helps to improve product persistency, and increase the time before the benefit is likely to be utilized. I hope that some of you have seen our ads announcing these exciting upgrades in major financial publications.

Turning to our retirement plans business, overall, it was a solid year with record full-year sales. And the public sector fourth-quarter sales rose 8%, capping a very successful year in which we acquired and renewed a number of large and important plans despite a very competitive RFP process. In the private sector, we reported record sales for the year. However, flat fourth quarter sales were lower than expected, resulting in total sales growth for 2007 below planned levels.

The weakness in the fourth quarter sales was attributable to some of the changes we are making to improve the business model. In 2007, our efforts focused on upgrading sales management and recruiting wholesaler talent with the skill set that complements our new selling system. As a result, sales production suffered as we experienced higher turnover during the year. That being said, we can experience pressure on sales growth during the first quarter due to the lingering impact of turnover from last year.

Today, we are fully staffed with our pension specialists. Our expectations are very high for the private sector business and I am confident that the actions that we have taken will make us a stronger competitor going forward. Individual protection sales, first-year individual life products were at their highest levels in three years as the actions we’ve taken over the last several quarters to improve sales performance are taking hold. First-year sales of fixed year life products increased 75% and individual investment life first-year sales were up 23% over last year. Notably, for the first time, sales of our fixed UL product ULtimate reached approximately a third of our total first-year individual life sales.

Corporate and bank owned life insurance first-year sales were significantly lower than both prior periods. However, we typically see large fluctuations in corporate product sales results across the quarter. As you know, a key areas of focus for us during 2007 was on improving the performance of our individual protection business. Some of the actions we've taken over the last year include strengthening the competitiveness of our individual life product portfolio, continued expansion of our penetration in the BGA channel and accelerating sales through wirehouses and specialty firms such as M Financial, with the introduction of new proprietary products and services. While we have more work to do, we are encouraged by the results this quarter and the positive impact the deepening relationships with our partner firms is having on improving sales momentum.

Now, let me turn to our continued discussion on how our team is executing and update you on the unique value our distribution strategy brings to the market. As Mark outlined in his comments, there are several factors that are driving changes in how financial services products are distributed. What we are seeing in this field is that client firms are becoming more selective and seeking manufacturing partners that are easy to do business with, and that can help them achieve their broader firm objectives. To capitalize on these trends, we've made significant investment in the development of a focused distribution strategy, that is supported by relationship management, a consistent sales process, robust marketing and making sure that we're bringing in and developing top tier sales professionals. These initiatives are foundational to achieving the ultimate goal that Mark outlined, more fully leveraging the collective scale and unique value proposition inherent in our businesses to facilitate a superior means of bringing innovative financial solutions to the market. This is all part of our commitment of delivering upon simpler solutions.

Our distribution strategy is proving effective as evidenced by the positive sales results that we believe directly attributed to the changes in our distribution model. To a large extent, the non-affiliated sales momentum that we are achieving across our businesses is being driven by increased sales volume associated with select business partners. As I have mentioned in my opening remarks, over 70% of our non-affiliated sales are now coming from our focused distribution partners.

We are employing a similar strategy with respect to individual advisors, focusing our efforts on a more targeted basis. These efforts are also showing results. During 2007 we targeted approximately 6,500 producers across multiple channels that had only sold one-product with us in the last 12 months. Following our efforts, over a third of these targeted producers subsequently sold additional product.

As we've talked about in the past, the restructuring of the Nationwide Financial Network has led to a significant decline in productivity due to the magnitude of the transformation. Mike Hamilton and his team are making good progress towards building an effective retail distribution business. To-date, most of the organizational changes have been completed, including better alignment, better aligned incentive-based compensation plans and more consistent operating and sales processes. As a result, we will benefit from significant cost savings associated with NFN distribution. Moreover, we are encouraged by the 8% sequential improvement in sales through the Nationwide Financial Network during the fourth quarter and expect further improvements as the transition progresses.

The progress we are making is just a beginning. Our task now is to fully leverage the Nationwide sales process to drive sustainable long-term growth. So, during 2008, we’ll continue to build on the strategy, working to align our resources and distribution processes to more effectively serve the client firms and investment professionals. To address these needs, Nationwide brings a comprehensive portfolio of innovate financial solutions backed by trusted brands, outstanding service, and an organization that is designed to be and is easy to do business with.

Now, I will turn the call over to Tim.

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

Thanks, John, and good morning everyone. Before we get into the detail behind the quarter, I'd like to reinforce Mark’s comments on our overall performance. Our fourth-quarter results underscore the progress we are making to improve sales and bottom line performance. Despite the volatility in the capital markets, our risk management capabilities are proving effective. Our balance sheet remains strong and we achieve solid progress in growth and earnings and operating return on equity, demonstrating progress towards our longer-term objectives.

Given the focus this quarter, I'll begin my discussion which some detail around our realized losses, followed by an overview of our investment portfolio and a summary of our key exposures within pertinent asset classes. During the quarter, we had $66 million of net realized losses. 53 of this was driven by impairments, of which 14 million was sub prime and another 34 million was on a single corporate bond. The other significant component of the 66 million was a $9 million lost related to living benefit hedge and liability mark-to-market. Our perspective is that the accounting for the valuation liabilities created earnings volatility that does not necessarily reflect the underlying economics of the benefit. It is not indicative of the underlying performance of the business.

Turning to the investment portfolio, our strategy around managing investment portfolio incorporates a strong asset liability management discipline focusing on a liability based investment approach. This results in an asset portfolio aligned with the risk and return requirements of the product it supports. Our investment team focuses on fundamental analysis and underwriting, requiring sufficient transparency into the underlying collateral to evaluate risk adjusted relative value. This disciplined approach helped us avoid the temptation to enhance yield through investments in overly complex structures. As a result, we have a portfolio which has performed well despite our market conditions. That said, we remain cautious regarding the continued market uncertainty, but as of now are comfortable with our evaluations.

Let me spend a moment reviewing key exposures and asset quality within the portfolio, beginning the sub prime and Alt-A. Again this quarter we have provided a detailed disclosure on our website. In summary, our sub prime is slightly over 800 million or 2% of our general account and Alt-A is 2.2 billion or 6% of our general account. Combined 99% of these are rated AA better. I would note that S&P has another round of downgrades in January and none of our holdings were downgraded. Our CDO and CLO exposure is small at approximately 340 million or less than 1% of our general account. It does not contain any sub prime. 91% rated AA better and are primarily backed by investment grade corporate debt, providing good visibility into the underlying collateral. So, we’ve had no writedowns of CDOs or CLOs in the quarter.

Our financial exposures to financial guarantors is also small at approximately 600 million. This exposure process categories and it’s primary exposure to monoline RAV securities versus direct holders. Our purchase decisions are based on the characteristics of the underlying collateral and not the guarantee. Our commercial mortgage loan exposure is predominantly whole loans originated and underwritten by our real estate team. This core competency of our investment team has resulted in a mortgage loan portfolio that is well-diversified by geography and property type. We hold 8.3 billion mortgage loans with the current loan to value ratio of 67%. Delinquencies in this asset class continue to be at historical lows and property values are holding firm. Given our focus on whole loans, we’ve relatively small exposure to CMBS, currently 1.2 billion or 3% of our general account. 92% of our CMBS portfolio is rated double AA or better.

Now moving on to normalizing items in the quarter. The only unusual items that impacted net operating results was an unusually high effective tax rate associated with lower than normal dividend received deduction in the quarter. Our reductions related to DRD this quarter were 4 million below our run rate which had a $0.03 negative impact to our earnings per share. So, as Mark noted, our normalized run rate EPS for the quarter was $1.19, which is $0.07 head of the normalize number we discussed last quarter, and $0.21 the head of the number we discussed year ago, before the impact of incorporating NFG into the prior period results. Within the segments, there were several items that were outside of what we would consider a run rate going forward. However these items essentially netted out and had no impact on the consolidated bottom-line results.

Individual investments and retirement plans both benefited from prepayments that were above assumed levels and operating expenses that were below what we would expect going-forward. These items added 6 million to individual investments and 8 million to retirement plants net of tax and debts. Individual protection also had increased prepayments. But these were more than offset by higher life benefit expenses, resulting in a negative $2 million impact to this segment. In corporate and other, the combination of operating losses related to our commercial mortgage loan securitization business and increased legal expenses negatively impacted this segment by $12 million.

Turning now to the drivers of our results this quarter. Operating revenues net of interest credited increased 5% versus last quarter. Looking at the equity market impact in the fourth quarter, SMP was down nearly 4% on a point-to-point basis, and as a result ending variable account values for the quarter were also down. However, on a daily average basis, the SMP result almost half a percent. So, we didn't see a modest increase in our asset-based fee revenue. Interest rate income increased over 8% versus prior quarter, primarily driven by increased prepayments penalty income this quarter and lower alternative investment income in the prior quarter. Net of these, spread income was flat.

In our life business, we saw a solid increase in life insurance policy charges, a portion of which was driven by strong universal life production in the quarter. With respect to expenses, operating expenses were below prior quarter and were well below prior year, primarily due to seasonality and higher expenses in prior year combined with good expense discipline across our segment.

Turning now to our outlook for 2008 we expect enhancement to our core operation combined with the addition of the bank and mutual fund business and disciplined expense management will result in further progress toward our long-term financial targets. Our 2008 operating plan includes revenue and earnings growth and moves us towards our stores ROE goal of 13%.

So, let me briefly cover a few highlights of our 2008 guidance. We have maintained margin and spread guidance within each of our businesses with the exception of individual investments. In this business, we are increasing the margin guidance to 42 to 47 basis points, reflecting the contribution of NFG fund to this business. For sales guidance, we are pleased with the momentum we are seeing in the individual life sales and expect it to continue in 2008. Therefore, we are guiding to 15 to 20% growth in first-year sales for fixed life.

In variable annuities, we’ve delivered on our guidance of 15 to 20% growth for two consecutive years and are guiding to that level again in 2008. This is an ambitious target, particularly given the growth we’ve achieved in 2007 in the volatile equity market. On a consolidated basis, we’ve increased our full-year ROE guidance to 11.8 to 12.2%. This guidance is based on an assumption that the S&P 500 will increase 6 to 7 % throughout 2008. However, it's the equity market will just stay down 10% through the remainder of the year, our more equity sensitive businesses, namely individual investments and retirement plans, will likely seeing margins towards the lower end of the range of guidance. This could also trigger DAC unlockings which are not incorporated in the guidance.

Additionally, earnings in the corporate and other segment could fall below the range of guidance, given pressure on our alternative investment returns. And the consolidated ROE could be impacted by at least 50 basis points. A final note on 2008 guidance. We have made significant progress on our evaluation analysis around implementation of FAS-157. Do not expect its implementation to have a material impact on our results.

Finally, let me touch on capital management. In December, our Board authorized an additional 500 million of share repurchases. During the last couple of weeks in the fourth quarter we repurchased 29 million of shares options in the open market and are also completed 24 million during the first few weeks of January during our backup… before our… prior to our black out period. For the full-year 2007, we returned 656 million to shareholders through repurchases and quarterly dividends. Disciplined capital management remains the cornerstone of our strategy and our priority for uses of capital will remain in areas that will drive growth and improve returns in our businesses.

That completes my prepared remarks. Denise, can you please open the call for Q&A.

Question and Answer

Operator

Operator: [Operator Instructions]. Our first question comes from Tamara Kravec from Banc of America Securities.

Tamara Kravec - Banc of America Securities

Hi. Thank you. Good morning. A couple of questions in the 401K business, and you talked about the efficiencies you're going to recognize between your public and private. But specifically in 401K, your surrenders ticked up and the markets are difficult. Are there any specific things you're doing to address retention there? And the bank and the mutual fund operations, at your Investor Day, you had looked for 10 million of earnings contribution from the bank and about 20 from the mutual funds of ‘08. Has that changed based on the progress that you have made?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

This is Mark. Let me touch on the retention first. Clearly in the 401K business, you are right, I think there was a slight pickup in the fourth quarter, probably have a few larger cases that left us. We have retention efforts across all the businesses. One of the key efforts is actually one of the things that John talked about, which is getting back to advisors that used to do business with us, that aren’t doing today it and re-establishing relationships with them. The team also has an active list of what I’ll say cases at risk and cases at risk would be defined as again maybe advisors not doing business with this in a while. It would be the size of the case, a number of things that would factor into that an actively than re-establishing relationships with both the advisor and the pension plan administrator as well as the plan sponsors. So, we will continue to leverage those efforts as John said now that we are fully staffed across-the-board there going forward. I think as far as the bank and mutual funds, our guidance, can you add a comment here.

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

On the bank, I think we are on track, at expectation. Clearly the markets… and as the Fed continues to take rates down, could put some pressure on that, but we still think we are right in that range at this point. NFG, we are probably a bit ahead of where we thought we were at the time of the investor conference.

Tamara Kravec - Banc of America Securities

Okay. Great. Thanks.

Operator

Our next question comes from Tom Gallagher from Credit Suisse.

Thomas Gallagher - Credit Suisse

Good morning. Couple of questions. First is a follow-up on the private sector pension. I know your sales guidance is 8 to 10%, but in the light of the net outflows this quarter, do you... would you see the sales growth being enough to offset the tick up in redemptions? Do you see that turning net flow positive? And then also if you can comment on how you see the impact of auto-enrollment playing out in your business? Do you think that's going to have also a positive impact and is that a big dent to your 8 to 10% sales growth?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

First of all, we do expect positive flows in the 401K business next year both from an increase in sales as well as just continued efforts around retention. Auto enrollment, I think in a small case market, we will have a very positive long-term impact. It is to the extent that we will see some impact on it in '08 as plans start to adopt it. It is factored into that guidance at this point, because we do expect it’ll be small dollars, small accounts in the first year, and we will be at a much better position as we kind of roll through this year and who adopts it. Right now, it's a lot of education with both plan sponsors and plan administrators, so they understand the benefits for their associates to doing it. So I would expect to see a longer term more positive impact but it is what it is for '08.

Thomas Gallagher - Credit Suisse

And so Mark, the… it's going to be a fairly gradual process as it relates to the impact on sales. Is that fair to say?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

That's fair to say.

Thomas Gallagher - Credit Suisse

Okay. The... I guess a question for Tim, can you discuss... I guess especially in light of what's happening in the equity markets, can you discuss a bit about your regulatory capital sensitivity to equity markets between CARVM between the reserved volatility from C3 Phase 2 and also whether or not you have purchased any hedges to protect against a potential substantial decline in equity markets?

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

Yes. I think the philosophy of our hedging program exactly coincides with how C3 Phase 2 operates. So, our hedge program was never built to be a program that hedges the GAAP accounting income-statement. It was more based on economics, which is what you are going to see in the C3 Phase 2 space. So, our hedging will absolutely help offset any downward impact on capital that we would expect from C3 phase 2 and CARVM.

Thomas Gallagher - Credit Suisse

Okay. And Tim can you give… I don't know if you have any numbers in front of you, or you could give some ballpark estimates, how big is your, can you remind us how big your CARVM is and do you have something like S&P puts that are protecting directly proportional against a sudden big drop in the equity markets?

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

Well, CARVM isn't there yet, and mostly what we're hedging against on our hedge program is not hedging against mortality and expense fees. So, we're going to still have sensitivities on our performance in our revenues or M&A fees. It's mostly hedging against living benefit liabilities, which is where we think you can have large shocks to your capital position.

Thomas Gallagher - Credit Suisse

Okay.

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

Right now, for example, on the... for the most part, we are under old CARVM rules not new VACARVM rules. So, effectively on the VA business, we're still at 'book value reserves' on things that don't relate to living benefits. VACARVM will change that when it gets implemented. And it will be more of a stochastic based approach similar to the way, C-3 Phase 2 operates for capital.

Thomas Gallagher - Credit Suisse

But, the way it stands today or, at least as I've understood it, you have essentially the reserves that equates to the amount of surrender charges backing your variable annuity?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

A little more than that. It's... reserves are generally somewhere between full fund and surrender value.

Thomas Gallagher - Credit Suisse

Okay. And I guess my direct question on that is, so let me give you a hypothetical example. Equity market fund 15%, and then there is going to be a negative, immediate impact on your capital. Do you have anything in place to hedge against that drop?

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

We are not putting puts on reduction due to impact that the market might have on the M&A fees.

Thomas Gallagher - Credit Suisse

Got it Thank you.

Operator

Our next question comes from Darin Arita from Deutsche Bank.

Darin Arita - Deutsche Bank

Thank you. Just a question on your ROE target as we think about your outlook for 2008, it's about 11.8 to 12.2% ROE. And I was just wondering Nationwide has many initiatives in place throughout 2008 and 2009, but what do you think is the biggest lever to get the ROE up to 13% by 2009?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

Well, Darin, it's… as we discussed a couple of years, it's two main things, and one is returning to a better cash flow position in our core business, the annuity business. We obviously need the markets to get back to the level at which we stated them and calculated them in the guidance, and we need to be able to manage our excess capital, which I think we showed in 2007, and for a part of 2006 that we made very good progress in terms of managing capital. So, it's really those would be the two largest components. And then the third I'd say is clearly maintaining our focus on expenses and our discipline around continuing to fund new initiatives while always challenging our core and base expenses and see how much of our initiatives that we need to spend money on can be funded through reductions in core expenses.

Darin Arita - Deutsche Bank

Okay. It seems like a very strong pickup from '08 to '09 and I was wondering if you're successful at that with that momentum continuing to give beyond 13%?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

Yeah. We are not ready to go beyond that at this point.

Darin Arita - Deutsche Bank

Right. Thank you.

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

Operator, if there is... are there any more calls in the queue?

Operator

Sir, I do not have any questions at this time.

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

Okay. All right. Well, we would like to again thank everyone for joining our discussion of results. And as always, if you have any further questions feel free to call myself or anyone on the IR team. Thank you.

Operator

Excuse me, sir. I do have a gentlemen that just went in. Excuse me. Mark Finkelstein from FPK.

Mark Finkelstein - Fox-Pitt Kelton

Hi, good morning. Yes. I think I was in there earlier, but I wanted to ask you a few questions. You made the comment that you are not expecting any impact from 157, I mean just looking around, others are. Can you may just talk about why you don't see any impact from this?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

We spend a lot of time looking and debating that, and in our view and our process, when we were valuing our liabilities under FAS 133, we had used a lot of the same assumptions in terms of behavior and dynamic lapsation in our valuation model as we are using in our pricing model. In our pricing models, we determined this process are built to... the assumptions are built to cover you and a majority, a lion share of your scenarios, to take you out to [Inaudible]. So, as we have looked at our assumptions and we have spoken with peers in the industry and as we have spoken to consultants, we have come to the conclusion that we in fact have embedded risk margins in our pricing assumptions which we are using in the... already using in our valuation models, and that's where we came to that conclusion.

Mark Finkelstein - Fox-Pitt Kelton

Okay. That makes sense. I apologize if you have already stated this, but when --what is your expectation on US VA flows in 2008, when that should turn positive?

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

For the full year we expect it to be positive. It will ramp up during the year, I would expect probably positive in the first quarter, but for the full year we expect to be positive.

Mark Finkelstein - Fox-Pitt Kelton

Okay. And then just on the 500 million authorization, is there anything you can say about, I guess, two things, one is any participation by Mutual and two about intentionally in accelerated?

Mark Thresher - President and Chief Operating Officer, Nationwide Financial

Let me comment on the Mutual company and Tim can talk about accelerated. I mean, we continue every time, we increase the authorization, have discussions about their intentions and we will continue to do that at this point time. They have continued to decline to participate, there are some tax ramifications at their level of participating, and they continue to look for ways to work through that, but at this point have not concluded a way to effectively participate.

Timothy Frommeyer - Senior Vice President and Chief Financial Officer

And regarding any accelerated share repurchase, that always on the table. As you know, we did two of those in 2007, and we would use… potentially use that as 2008 [inaudible].

Mark Finkelstein - Fox-Pitt Kelton

Okay. Great. Thanks.

Operator

Mr. Barnett, at this time I do not have any further questions, would you like to make any closing remarks?

Mark Barnett - Vice President, Investor Relations

Just once again thank everybody for joining us today and look forward to keeping you updated in the future. Thank you.

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