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Executives

John D. Johns - Chairman, President, and CEO

Richard J. Bielen - Vice Chairman and CFO

Carl S. Thigpen - EVP and Chief Investment Officer

Analysts

Andrew Kligerman - UBS

Edward Spehar - Merrill Lynch

Thomas Gallagher - Credit Suisse

Darin Arita - Deutsche Bank

Mark Finkelstein - FPK

Jukka Lipponen - Keefe, Bruyette and Woods

Eric Berg - Lehman Brothers

Protective Life Corporation (PL) Q1 FY08 Earnings Call May 8, 2008 ET

[Call Starts Abruptly]

John D. Johns - Chairman, President, and Chief Executive Officer

We had $0.19 per share of negative mark-to-market on securities designated for trading in the corporate and other segment. This trading account has been around I guess seven or eight years now, its been a contributor of 80 to 100 basis points of spread income and we think of it really as just an almost a stable value contract. Never we've seen this kind of volatility and the marks on it. It's a short duration portfolio, its very high quality, we feel like all the assets in the portfolio... we believe the money is good and they'll payoff pretty quickly. We have taken some steps to change the way the portfolio works to reduce and mitigate volatility in the future. And we do believe that this component of the charges is likely too reverse. We expect it to reverse even during the course of this year and we will explain it to you in just a minute.

With respect to below the line items, we did have $0.23 of share of net realized losses that is attributable to $0.15 per share of mark-to-market on that $200 million of corporate credit default swaps, that were in place at the end of the quarter as Rich will mention in just a moment. That's largely reversing as we speak, and in fact we have actually realized cash to a significant extent as we've taken some of those positions off and again we think we will see the end of that. The remaining amount resulted primarily from mark-to-market, so on various interest rate hedges that we have in place to manage interest rate, we ask around the company and again Rich will give you more detail on that. But the balance sheet remains very strong, I think we have very good capital position, our investment portfolio continues to perform very nicely, we didn't have any impairments... permanent.

During the quarter real state portfolio remained very, very solid. Our problem loans continued to be at historically very low levels and we don't really see any cracks in that portfolio. We've said over the last couple of years that we felt challenged by the interest rate and spread environment and we've said this year that we feel like its more favorable environment to us on balance and we continue to have that view as you can see it's from the numbers we report today. The ability to invest our money at credit spreads... that's going to make sense to us is certainly something that encourages us.

I think... now I am going to turn it over to Rich and let him kind of just walk you though the divisional numbers and also go through some of these charges in bit more detail. Rich?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

Thank you Johnny. I would first point out that in addition to the information contained in our press release we have certain supplemental financial information available via our website www.protective.com. Also this conference call discussion includes forward-looking statements which express expectations of future events and/or results. Actual events and results may differ materially from these expectations. Please refer to our press release in the Exhibit 99 of the company's most recent 10-K/10-Q for more information about factors which may affect future results. The discussion may also contain non-GAAP financial information, please see our website for additional information and reconciliation to GAAP financial measures.

What I would like to do here is, we just start out... we did have operating earnings for the quarter of $0.73 as compared to a $1.21 in the first quarter of the prior year. And you might just see the first quarter just to remind everybody, we did have a sale of metrics direct during that quarter. We also had substantially higher participating income and also prepayment fees. On the way I would like do a discussion this morning, is I'm go through the lines of business, then I'm going to go through all the fair value items, then I am going to make some comments regarding investment income and what 0we see there going forward.

Starting with the Life marketing division, we had strong earnings of $46.4 million compared to $65.3 million in the first quarter of '07. Last year did include $15.7 million from the sale of metrics direct. Also just to remind everybody, we completed the AXXX transaction in the middle of last year and income in this line also had $4 million related to those reserves that we later financed. We also had very favorable mortality last year, it was favorable 5.8 million, while this year's quarter is in line with our expectation of our favorable $2.8 million. Life sales were $43.3 million in the first quarter versus $49.5 million in the first quarter of '07, down 12.6% but our UL sales, which is where we're focusing on grew 1.5% as compared to last year at $16.3 million versus $16 million last year. We've also launched a new UL product beginning at the second quarter which we think will be very competitive in the marketplace.

As expected, our terms sales continued to slow and terms sales this quarter were $27 million in the first quarter versus $33.5 million in the first quarter of last year. But few other items that impacted this quarter and this was actually very big quarter and above our expectations unlike marketing where we saw our investment income in the spreads in this line contribute about $1.9 million of additional income versus our prior expectations. And then as we mentioned previously we've been undergoing a number of consolidation efforts and efficiency efforts and we did see a couple of billion dollars of expense reduction in the number this quarter.

Moving to the acquisitions division, we've now completed all of the conversions related to Chase. We've finished that in the first quarter. We had some minor ones, so earnings this quarter were $33.6 million in the current quarter compared to $32.2 million in the first quarter of '07. Our expenses related to Chase Insurance Group are down significantly versus last year where the savings and transition expenses now are being offset by the expected runoff of the block. But Chase continues to perform in line and actually slightly better than our original expectations and the remaining core block acquisitions were also above expectations for the first quarter of '08.

Moving to the annuity lines, we had earnings of $2.5 million in the quarter compared to $5.6 million in the first quarter of last year, but this one of the business that were impacted by fair value changes. We've had fair value changes of $5.7 million this quarter. So if those had not occurred, we actually would have had an $8.2 million quarter which is on the high end of our expectations. Both fair value changes consisted of $4.2 million related to the equity index annuity and the negative impact of $1.5 million related to the GMWB rider.

Sales in the quarter were a record level of $612 million, they were up 94% from the first quarter of last year and 48% from the fourth quarter of this year. We show our fixed annuities continued to show solid sales numbers in our MBA product or mediate in our SPDAs, our variable annuity sales increased in the first quarter by 17.5% to $92 million, despite low equity markets. And we are in the process of launching a new GMWB rider here at the beginning of May which we hope will give us some continued momentum in that line of business. We continue to focus on expanding the distribution in the annuity line. We had net positive cash flows in all the annuity lines again this quarter and then our first quarter deposit balances were $7.8 billion, an increase of 16.2% over the prior year quarter end. And in this line we did see the benefits of some higher yields and higher spreads which contributed to that $8 million number that we saw, we excluded the fair value items.

With respect to the stable value division, we had very strong earnings in the quarter of $16.2 million, up 33% as compared to $12.2 million in the first quarter of '07. Our operating spreads in the first quarter moved up to 126 basis point versus 92 in the first quarter of last year and 101 for the entire year last year. That 126 basis points represents a record quarter of spreads for us in this business. We do expect to continue to see triple digit spreads throughout the year but we do have approximately $1 billion of contracts that are coming up for maturity over the year. So how we manage that over the balance of the year will dictate the exact level of those spreads.

Sales in the first quarter were very strong, it was $638 million. We got off with a good start with $450 million in institutional funding agreements, write out in January. We did $113 million in retail funding agreements which is an area that we had seen some decline in prior years and we did $74 million of traditional guaranteed investment contracts. The ending deposit balances for the quarter increased to $5.2 billion, which is up about $100 million from the prior quarter. With respect to the asset protection division, the segment delivered solid results in what is a very strained auto and marine marketplace. The pre-tax operating earning of the quarter were $9.9 million as compared to $10.1 million in the first quarter of last year.

We did have a sale of a small insurance subsidiary that positively impacted earnings by about $600,000 this quarter. Vehicle and marine service contracts are the primary product lines in this division where it continued to perform well, experiencing favorable loss ratios. But sales in this line are being impacted by what you are seeing in the general economy with the depressed marine and automobile market. We continue to believe that the favorable loss ratios will continue to allow us to report solid results but probably on the lower side of our expectation as we started the year.

Then the last segment is our corporate other lines. Corporate and other segment includes net investment income and expenses not attributable to the business segment. This segment also includes earnings from several non-strategic and discontinued lines. The first quarter pretax operating loss of $30 million in this segment really consisted the major line was the trading portfolio that we allocated the segment. That portfolio is $419 million. We'd experienced a loss of $19.4 million. We also saw our total participating mortgage income this year... this quarter be $3.6 million, $1.6 million of that is in Corporate and other $2 million is allocated to the lines. That's down $5.3 million from last year. We also saw a decline in our mortgage loan prepayment fees from one year to the other of another $3.2 million in this quarter.

So, if you kind of back out the reductions and participating income and the trading loss that explains the bulk of the $30 million loss in that quarter. With respect to the investment portfolio, we continue to see our asset portfolio being very solid. We continue to reposition the assets in the portfolio to try and generate higher yield and we are seeing some of the benefit that we saw it in like marketing, we saw it in annuities, we saw it in favorable value. Our problem loans and foreclosed properties continue to be less than 0.2% of the mortgage loan portfolio. The total problem loans we have is a little over $7 million. We did not see the need to impair any assets in the first quarter. We did increase our Alt A mortgage backed holdings in the quarter by about $389 million but literally 93% of these new purchases were rated AAA and any of the balance were also rated investment grade as we purchased those. We saw an opportunity there.

Now, I'm going to go through the all of the fair value items and some other comments on investment income. The first item that I know a number of you on reading the notes this morning, had questioned about the trading portfolio. On the $419 million portfolio, and in the supplemental there is a breakdown in the quality, they are all investment grade. There are no below investment grade bonds in there. There were no sub prime bonds in there in terms of the market. All the non-agencies securities in there are AAA and what we saw in the first quarter with the deterioration of the markets and the events surrounding Bear Stearns is we saw the assets in the portfolio decline in value by approximately $10 million.

In order to manage the interest rate in that portfolio to a duration of less than one, we have related swap agreements that are actually appreciating in value, meaning that for us they were created losses of approximately $9 million in the quarter. So the combination of those two items resulted in the $19 million trading loss that we have reported. What we do is we project out the portfolio over time and look at it. We expect that for the balance of the year approximately 20% of this portfolio is actually going to mature and pay off and so what we've done is try using current rate environment, try to project out the net yield that we will earn on the difference between the assets and those related hedges. The expected price of the portfolio at the end of the year based on today's yield curve and the expected price of the related hedges on that. And when we combine all three items together we should expect to see the majority of this or the entirety of this trading loss that we've recognized in the first quarter recover over the balance of the year.

I would tell you absent any real changes in the market that recovery will probably be a very steady kind of $2 million a month, not that you will see it all recovery at one time in the market. And the reason that we have some level of confidence in this portfolio is that the average life is a little over three years, so we know it is coming to its maturity.

With respect to the fair value item in the annuity business, as we indicated in the EIA that was $4.2million and the GMWB was $1.5 million. We've now seen two quarters in a row where the fair value items in this business have gone negatively against us. We have looked at a model as of April 30 and we see about $400,000 or $500,000 of recovery since quarter end in terms of that portfolio. We expect to see continued recovery but the combination of those two items we believe over the balance of the year, it's reasonable to expect that we should substantially recover both of them in their entirety.

With respect to the below the line items, one thing that I know is a little confusing when we look at the optics and to remind everyone is that due to the modco relationships we have in the Chase business, we are marking-to-market those modco portfolios and there is a related derivative and those moved about $28 million or about $0.26 to $0.27 of share and so when we described in first paragraph the impact of the net lose, we kind of backed out and so, when we looked at the realized loss below the line for the first quarter, we saw that it related primarily to two items. The first item was our credit derivatives portfolio. During 2000... the summer of 2007 when spread started to get wider, we wrote some credit default swaps on corporate credit industries including the investment grade, the high yield, and even the bank loan index. We wrote a total of $210 million of contracts, the mark-to-market on those for the first quarter was $15.2 million against us. Since the first ... the end of the first quarter we have a seen a substantial recovery in those. We have now closed $125 million of those contracts leaving us now only with $85 million of exposure and the combination of the prices in which we've closed those contracts and the current mark-to-market on the remaining $85 million, we have recovered in the entirety the $15.2 million mark-to-market loss that we saw in the first quarter of this year.

The final item related to fair value are related to interest rate hedges and as all of you are aware, we have a commercial mortgage business that has a pipeline. We are also heavy users of mortgage backs were we hedge our negative convexity. We also use some interest rate related items related to our holding company. As a general rule, we are hedging against higher rates and with the drop in swap rates and interest and treasury rates in the first quarter, those hedges went against us to the tune of approximately $8 million when we netted them all out. We have marked those to market as of yesterday and we believe on a mark-to-market basis we've recovered a little more than a half of that $8 million, so somewhere between $4 million to $5 million.

So to kind of summarize, the trading portfolio we believe is recoverable over the balance of the year and we are pretty confident based on the current conditions. The annuities are mark-to-market we see some recovery over the balance of the year but it should be relatively small differentials as we go on. The credit derivatives, we have now recovered all of that based on current marks as of yesterday and on the interest rate related derivatives we've covered approximately 50 plus percent of that based on yesterday's mark-to-markets.

On the other two comments I'd like to just make is with respect to investment income. One of our challenges as we went into this year was we were forecasting a reduction of participating income from approximately $40 million last year to $20 million this year. In the first quarter, our participating income was actually below the run rate, it was only a $3.6 million. But as you can see in some of our above the line businesses like marketing annuities and stable value, we recovered all that and we think that's a very healthy kind of tone for us in the future. We think the higher yields we've been able to put on are more sustainable over time, and it reduces our reliance on the core transaction related activity in terms of the participating income portfolio.

The other thing that will be very subtle, that could cause a penny or two of volatility for the next couple of quarters, we have a substantial number of assets and liability that are tied to LIBOR. But they are tied to both one month LIBOR, three month LIBOR, and six months LIBOR. So when you see a drop in rates that we've since the beginning of the year of about 300 basis points, you could get some mismatches in there that's also... we said over the balance of the year.

We don't think it's an issue for the year, we just think maybe the second quarter will be a little bit lower, the third quarter will be a little bit higher like that. And then the final item relates to capital management, in the first quarter, we purchased approximately 450,000 shares of stock. We have repurchased those at an average price of about $38 per share and added a total expenditure of about $17.1 million. And with that I will turn it back over to Johnny for final comment.

John D. Johns - Chairman, President, and Chief Executive Officer

Yes thanks, Rich. Let me just make a few concluding comments regarding our outlook for the rest of the year, and our guidance, our earning... operating earnings guidance for the rest of the year. So in summary our outlook for the year really hasn't changed very much from where we started at the beginning of the year. Although this quarter is noisy with the mark-to-market impaired value items and that we think the underlying performance is pretty much in line and maybe a bit better than we would have expected in the first quarter in terms of the real core economics of our various business lines and our investment portfolio.

With regard to our life insurance business, we do remain positive in terms of how we see it rolling out during the rest of the year. Those of you who attended the Investors Conference will recall that our strategy there is to stabilize our term sales. We reprised the term products and the brokerage channel which is our largest distribution channel for life insurance very early in the year. And then as Rich indicated we're bringing out more competitive UL products as the year progresses. We have one that's out this quarter, we have another out in June and have some other for the rest of the year.

So we're really trying to execute a strategy where we stabilize term and grow UL, let me think that strategy is pretty much on track, for the year. You'll remember some of the benefits of that are that the Universal Life products do not present the profit emergency issues to near the degree we've seen with regard to the term products. So this strategy is helpful there, we currently think are better, anything that displays borderline strength to accumulate long life deposits and reserves from our customers. So we are constructive and positive in terms of how we have see our life insurance business playing out for the rest of the year.

Spend values kind of... let me then talk about annuities first. We're very bullish on the annuity and as Rich indicated we had record level of sales laid ahead of our own ambitious targets for the year and in the first quarter. We just rolled out a new withdrawal benefits feature in our variable annuity cards which is very much in the pack and competitive with everyone else in the industry. We have added some new fund families that have gained some excitement there, and early indications are that we are going to see some expansion of our variable annuity sales as the year progresses and that's very positive. But we think our fixed annuity business is also very, very solid right now. So, we are very bullish on what's going on in the annuity segment.

At acquisitions as Rich indicated we had good performance in the quarter, actually a little better than we would have expected the Chase integration is now largely complete. We are starting to see the full benefits of that acquisition. We remain quite active in the acquisition area. We have been doing a lot of work recently on some potential acquisitions, there are some strong ones, large ones out there that we are working on, we never are able to predict when it is actually going to land. But at least there is a good deal of activity and that's a good thing as well.

Stable value is kind of a mixed bag. We certainly are excited and pleased with the spreads that we are currently enjoying and that's something that does make us optimistic, its consistent with... comments about how this is a better investment environment for us. It's a bit challenging to issue stable value in the current environment. But we do have some strategies in place to mitigate that as well and we are hopeful that we will be able to stay on track with regard to our plans in that line.

Asset protection, again its become a pretty good line of business for us. The management there are doing a good job, I think managing risk and managing expenses. They do have headwinds because some of their sales are tied to... most of their sales are tied to sales of automobiles and marine products of England and we know that those sales are trending down. I think in U.S. all sales were down pretty dramatically in the month of March alone but it is not something that we are alarmed about. We do think that the business is solid and we have got good plans there and we think it would play out, maybe a little bit less contribute this year than we had hoped. But still not nothing we are terribly concerned about.

Rich indicated, everything is looking very nice and our investment portfolio, our capital positions are strong and building. So, we step back from all that. Again, we begin 2008 today about as we did at beginning of the year, as we shared at the investors conference. This year we think kind of it sets the stage for some even better performance in '09 and 2010. We're seeing nothing that will cause us to back away from sort of the range of expectations with earnings and returns that we put forth at the investors conference. We still think that it's realistic for us to attempt to achieve the financial objectives that we have, with 8% to 10% EPS growth and 15% to 14% ROE. We think that our expectations there remains intact.

In terms guidance, we're all going to tweak our guidance just a little bit. We're going to bring the top end of the range down from $4.20 to $4.15. The low end stays at $3.80, gives you a best estimate midpoint of $3.98 kind of range and again earnings can be volatile. So you would think it's appropriate to still have pretty wide range here.

A number of assumptions that go into that best estimate, I think we set them out in the press release but some of them are... we are continuing to enjoy mortality consistent with what we saw last year which is a trend of favorable mortality in our life insurance business. We do expect a debt extinguishment charge during the year of about $7 million as we continue to execute our securitization strategies when we move from one facility to another.

We think stable value should be a good contributor for the year. The challenge is just issuing but we do think we have some plans there that makes sense. We... as Rich indicated, in order to recover these fair value of mark-to-market charges that is affecting operating income, we are doing a stability in spreads, interest rates, look to the curve, and that sort of things from the conditions that currently exist or existed at the end of last weak. And it is possible I think, if the things would go the other way they could actually improve in which event results will be better than we forecasted.

We do assume and I think this is also the expectation that we will achieve our sales targets in our retail product lines, life insurance annuities, and APD. And we do expect to see that the investment income increases, we are seeing redeployment and higher yields. It's largely offsetting the decline, its just cutting mortgage income that we are currently experiencing.

So with that I think that's concludes our comments that we wish to make this morning and we'll turn it back to you for your questions.

Question And Answer

Operator

[Operator Instructions]. Our first question comes from Andrew Kligerman of UBS.

Andrew Kligerman - UBS

Hey good morning.

John D. Johns - Chairman, President, and Chief Executive Officer

Good morning.

Andrew Kligerman - UBS

Rich you sound like you got a cold tell Johnny to give you the day off.

Richard J. Bielen - Vice Chairman and Chief Financial Officer

It is allergy in the south.

Andrew Kligerman - UBS

There you go. Just starting now with that terrific spread and stable value 126 basis points versus 102 in the prior quarter, could you dissect that on the asset liability side. Its sounds like LIBOR may inflate into it and then you were commenting little earlier how second quarter might be down and third would be up. Maybe just gives us a sense what the components were? And then where it might be going forward?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

The actual yield in the quarter were down about 5 basis points, primarily that's a result of there are floating rate assets in that portfolio. So the absolute rate level is down a little bit. However, the liability rate level was down 28, 29 basis points and some of that has to do with resetting of liabilities in that portfolio. But some of that also had to do with when we have the strong sales in the first quarter that we actually wrote those contracts at lower rates than what we are maturing at the time. And so it will allowed us to accelerate the drop in our liability cost. So the benefit of the wider spread really came from the lower liability cost more so than change on the investment side.

What I was referring to is in that two places where LIBOR impacts us is in both stable value at corporate another and what happens is we have a number of contracts in there that have resets on one month LIBOR, three month LIBOR, or six month LIBOR and then we have assets on the other side, the reset on various industries and they are not necessarily perfectly matched to get into each other.

So when we look at the second quarter we see that there maybe some decline there as a result of those kind rebalancing overtime, and there is a similar impact in corporate and other with our cash investments and our holding company that can go through. And so, all I was trying to prepare everybody for is we may see a little decline with a little recovery in the third quarter as we go through that.

Andrew Kligerman - UBS

And when you say decline Rich are you thinking maybe a reversion to what you were in the quarter say in a 100 to 110 basis point range?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

I would say somewhere between the first quarter and the fourth quarter.

Andrew Kligerman - UBS

Okay great. And then just I was looking on the balance sheet and I noticed in the equity line of your portfolio, you went from $117 million in the fourth quarter to $289 million in the fourth quarter. Now if I team it... normally I would think that your investment acumen is projective and that's why it went up, but I would have seen that in the game line. So I am just kind of wondering what was done in the equities area to you see that number jump up.

John D. Johns - Chairman, President, and Chief Executive Officer

Andrew, Carl Thigpen, our Chief Investment Officer will answer that for you.

Carl S. Thigpen - Executive Vice President and Chief Investment Officer

Andrew we saw in the first quarter some really good opportunities to buy some preferred stocks that were A rated investment grade, that we had similar capital charges on similar rated bonds. And so we stepped into the preferred market and picked up some high quality preferreds.

Andrew Kligerman - UBS

Super, thanks a lot

John D. Johns - Chairman, President, and Chief Executive Officer

Thank you

Operator

Our next question comes from Ed Spehar of Merrill Lynch

Edward Spehar - Merrill Lynch

Thank you. Good morning everyone.

John D. Johns - Chairman, President, and Chief Executive Officer

Good morning

Edward Spehar - Merrill Lynch

I had a few questions I guess, the first if we look at the expectations about the mark-to-market, the fair value on the corporate side and also the impact on reported book value, can you give us any sense Rich about how much of that has been recovered already just from spread tightening?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

We did not run... we did not close our books yet to give you a number. We've seen as you know a substantial spread tightening in the quarter. The bulk of the mark-to-market change in the first quarter came from our non-agency mortgage backed portfolio which is mostly prime assets and AAA. Some of our retained CMBS from our own securitization and some other asset backs, and then we did see some decline related to some of the large financial institutions where we have corporate holdings. That was the bulk of the change when we looked at the difference between yearend and the first quarter. We not yet tried to ascertain what exactly is the change for the month of April.

John D. Johns - Chairman, President, and Chief Executive Officer

We are just focusing on the fact that we have a larger allocation to the mortgage backed securities in most companies in the industry that's been true for the last 10 or 15 years. And as Rich indicated ours is a prime well agency, it is AAA, they are very high quality paper but all of those kind of assets we are paying it with a similar rush at the end of the first quarter. So we did see a lot of spread widening and our prime mortgage backed securities since we've got higher allocation to that and most of you've probably seen... expect to see a little more FAS 115 volatility but we don't think that reflects any issues or economic issues or problems in the portfolio.

Edward Spehar - Merrill Lynch

I guess just one last question on the fair value. If I look at the $0.19 in the corporate and other, and the comments that you made Rich about the three reasons that you are assuming its going to reverse through the balance of the year, how much of that is sort of I guess, what portion of that $0.19 is sort of high confidence and versus sort of just reasonable expectation?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

The $0.19 breaks down; I'll give you the numbers that we have used internally. We expect the... kind of the next spread differential between those assets and the funding to represent about $12 million of that. We expect that the assets will appreciate approximately $3 million between now and yearend as they roll down the curve, and the latest swaps there mature in 2010 and we would expect their fair value based on the March 31st curve to be down about $4 million in value. So we literally just took the portfolio that had rolled it forward to December 31st, without any changes in the March 31st yield curve or spread environment.

John D. Johns - Chairman, President, and Chief Executive Officer

If the $12 million spread recovery, if you will its pretty much mathematical. As these things, this portfolio, I think its about $400 million portfolio, its been written down 3% to 4% but now that its written down we have a differential now between the spread on the securities and the funding cost and then we are going to recover what we've marked down. So mathematically it comes back with a short duration portfolio if you be just earn it out, unless you have credit default of some kind which won't progress. You don't know what happened but we don't see that happening. We think it's a very solid portfolio.

Edward Spehar - Merrill Lynch

Okay, that's very helpful. And then just one last question on the annuity line, I know that this one large immediate annuity contract that you had written in the last couple of year's maybe, has been a source of some short-term earnings pressure. Can you give us a sense of what happened with that block in the quarter?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

We... because that block is very lumpy with a number of, there is a small number of cases that is relatively large dollar amounts. We did not see any debts in the first quarter to help us on that. So the mortality drag is now actually about $4 million plus almost $5 million that went through that first quarter.

John D. Johns - Chairman, President, and Chief Executive Officer

And that's an important point, let us kind of get the sell side again. We are just stepping up, we have just stepped up in the last couple of years in the annuity business. I like certain maybe annuity business, we think it's a terrific product, its got a lot of growth potential, we saw a lot of problems with consumers, it's what people need when they don't have the kind of benefit pension plans anymore. But the way that business works as you write a portfolio of life certain annuity that says it has an eight year expected life or 12 year expected life. Normally you don't give many debts in the first couple of three years. They kind of lump out, 5 years to 15 years out. But you still have to put a reserve and the accounting for that is costing us $4 million to $5 million a quarter in our annuity line right now and it translates $0.15 to $0.20 a year in terms of sort of earnings drag while the portfolio matures. Once it's a seasoned portfolio, the new business coming on, old business going off, you have kind of a normal incidents of mortality and we won't see that. But we think the economics are good and we are just investing for the future and starting up the new business line. It is a significant drag not only on our important annuity results but on the corporate results as well as our old bills are out.

Richard J. Bielen - Vice Chairman and Chief Financial Officer

And Ed the way we were able to offset that from a normalized earnings perspective as we did see wider spreads in the annuity business then we have seen and the increase in the account value and so we saw a really healthy kind of run rate in the quarter but it still is being dragged down by the side.

John D. Johns - Chairman, President, and Chief Executive Officer

And that just going, the service is being a business that produced its $7 million or $8 million a quarter of normalized earnings, if you put that back in its maybe $12 million to $13 million a quarter of earnings.

Edward Spehar - Merrill Lynch

Thank you very much.

John D. Johns - Chairman, President, and Chief Executive Officer

Thank you.

Operator

: We will take our next question from Tom Gallagher of Credit Suisse.

John D. Johns - Chairman, President, and Chief Executive Officer

Hi, Tom.

Thomas Gallagher - Credit Suisse

Hi, good morning. First, couple of questions for Rich. We saw another insurer that reported last night wrote down a substantial amount of fund jumbos, just curious if you are seeing something similar at least from a permanent impairment possibility from a price action standpoint on your book and can you just remind us what exposure you do have to prime jumbos, that's my first question?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

The prime jumbos that we own are approximately if I must call a little over $5 billion and they are all AAA. We've not seen any downgrades there. We have seen the market value prices on those range from the low 90s to the mid 90s on what we believe are par security that probably have average lives to them of 3 to 5 years. Unless they've done something unusual, my bet is that they have some kind of bright line pass which we do not use on our impairment policy and so they kind of went a fowler their bright line test or they are deciding to sell them or something but we don't see any impairment related to our client mortgage backs.

Thomas Gallagher - Credit Suisse

Okay and I guess a related question on the Alt A side, what kind of yields are you getting, I know you'd mentioned that it is a little over $300 million of new money purchases to that asset class and also when you look at how that overall Alt A portfolio stands today, are you seeing any signs of deterioration now or is it still holding up?

John D. Johns - Chairman, President, and Chief Executive Officer

Yes, on the... most of the Alt A purchases that we made during this quarter were AAA or about three year average life and yields were 7 percentage range. So, very sure, very high quality, good yield. We are tracking those every month, their performance, and they are... there is no deviation from the performance that we have expected on those assets.

Thomas Gallagher - Credit Suisse

Okay and when we think prospectively what are the most attractive areas in your view, is it... would it still be on the Alt A side where you are seeing the best risk award.

John D. Johns - Chairman, President, and Chief Executive Officer

Well, you know, that market has firmed up a lot and there is really not a lot of products showing up out there. There has been some selective bid list that's come out, but with all the headlines you would think there would just be a flood of product out there and there is some product and we have taken a look at a lot of products, but a lot of them we just find unacceptable. So if we see similar product to what we've been buying we would probably take some more positions but we haven't been seeing that in the last month or so.

Thomas Gallagher - Credit Suisse

Okay, and then just one last question if I could also on the investment side. I know the problem loans in your direct merchant mortgage lending operation remained very low. Can you... what would your expectation be, let's say over the next 12 to 18 months, I presume just based on what's happening in the economy, we may see some softening. Are there any early warning signs that we should be thinking about there, thanks?

John D. Johns - Chairman, President, and Chief Executive Officer

Today we have not seen any pick up and 30-day delinquencies are... anybody calling in and saying right I need to come in and have meetings and talk about things. So... but, I would not be surprised with the tightness of credit and if we do have a further slowdown in the economy the things pick up. If you remember our philosophy of credit anchorage shopping centers which is food and drug, basic discounters which is the majority of our portfolio and then what I will call your basic apartment living kind of complexes. We think those are very good products to be in during a downturn in the economy. Obviously there could be related borrower issues, bankruptcies that kind of thing but I think we are sitting in a pretty good recession resistant kind of property tide and that has proved to be the case in the past.

Richard J. Bielen - Vice Chairman and Chief Financial Officer

And Tom, I think you are an observer of the real estate economy but you seem to be getting focused regionally to the problems. Its very market specific, Texas is a strong market for just about everything now and we got a lot of exposure thankfully in Texas. The Southeast generally is holding up pretty well, pockets of weakness in and around some of the major metropolitan areas like Atlanta. And in housing, certainly Florida has got tremendous challenges we think kind of across the board. But whether we are lucky or smart, we are just not concentrated in areas where the local economies are driving the problems in the real estate business and that plus what Carl said that we tend to be orienting toward uses of property that are less discretionary, I mean necessities of life oriented. It gives us, you know, I think reasonable basis for optimism and we will ride this cycle pretty comfortably.

Thomas Gallagher - Credit Suisse

Okay. And then one last follow-up for Carl, if I could. Just to confirm, do you have any meaningful exposure to short-term bridge loan financing risk within your commercial mortgage portfolio or is it pretty much all termed out.

Carl S. Thigpen - Executive Vice President and Chief Investment Officer

Ours is all pretty much termed out and we have a prohibition against the borrowers putting any kind of secondary or mezzanine financing behind us without our approval. And so we... as far as any additional leverage that's put on the property, we have controls over that.

John D. Johns - Chairman, President, and Chief Executive Officer

We are not... we very rarely do short-term lending.

Richard J. Bielen - Vice Chairman and Chief Financial Officer

Yes, we don't do any of the mez or seconds, if that's the question.

Thomas Gallagher - Credit Suisse

Yes, it is. Thanks a lot.

John D. Johns - Chairman, President, and Chief Executive Officer

Thank you.

Operator

Darin Arita of Deutsche Bank. Your line is open.

Darin Arita - Deutsche Bank

Thank you. Good morning.

John D. Johns - Chairman, President, and Chief Executive Officer

Hello Darin

Darin Arita - Deutsche Bank

Just going back to the Alt A securities that were purchased in the quarter, can you give us a sense of the subordination levels on those and were those purchased in the secondary market or the primary market.

John D. Johns - Chairman, President, and Chief Executive Officer

Yes, they were purchased in the secondary market and they were purchased at substantial discounts to face. The typical subordination on those...

Richard J. Bielen - Vice Chairman and Chief Financial Officer

Yes, Darin, they were probably in subordination levels approaching double-digits and again I think the key thing is they were relatively short average laws of about three years. There were even one or two of them that we purchased which were kind of re-limit to create a super senior charge which has substantial levels of subordination, whether senior is below it. So, the bulk of those Alt A purchases, it was more of a label issue in the marketplace, not whether there was any issues surrounding subordination or delinquencies.

John D. Johns - Chairman, President, and Chief Executive Officer

Darin, you'll recall too that the way we funded it, we stayed away from ARMs. These are generally level pay third year mortgages. They are seasons... generally they're seasoned. People in their homes have been making this level of payment. The FICO scores are very high, using them very carefully, selective. We look at lot of paper before we found any we would be comfortable buying. The largest purchases, as Rich mentioned was a reremick [ph] of some collaterals and it had close to 20% subordination on it. And plus other than the reremick's most of the time we bought at substantial discounts.

Darin Arita - Deutsche Bank

Okay, that's very helpful there. And then turning to stable value, Rich, you mentioned $1 billion is coming to maturity this year. How do we think about that and the potential effect on the spreads?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

Well the real issue for us is that we are very focused on trying to identify effective funding sources for that in the marketplace. We issued early in January the market for institutional funding agreement that closed down later in the first quarter. With the blackout period ending for most companies, we've seen some issuance in the last week or two and so, it just represents the challenge of... we need to figure out ways to write the business effectively but we're pretty confident that we can do that and continue to earn triple-digit spreads over the balance of the year.

Darin Arita - Deutsche Bank

And is there a way to label what the spread is on that billion dollars there that is coming to maturity?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

This is kind of lumpy. Some matures this quarter, the third quarter is last, some matures in the fourth quarter. We've got assets, so, I don't want an easy way of giving you kind of a label on either on that basis.

Darin Arita - Deutsche Bank

Okay, great. Thank you.

John D. Johns - Chairman, President, and Chief Executive Officer

Thank you.

Operator

Our next question comes from Mark Finkelstein of FPK.

Mark Finkelstein - FPK

Good morning.

Richard J. Bielen - Vice Chairman and Chief Financial Officer

Good morning.

Mark Finkelstein - FPK

Just...on stable value just going back to that real quick, you're pretty active in terms of kind of issuances this year and the targets are robust and you have the kind of billion coming off the books. I mean just to give Phil some perspective, I mean what are the new pricing spreads on that right now.

Richard J. Bielen - Vice Chairman and Chief Financial Officer

Triple-digits. We'd be comfortable writing that triple-digits. That's the reason we just kind of keep repeating it every night, only redefining it because it really depends on how we allocate assets, to which line of business. If Carl is able to identify another pool of Alt A's with a 7% yield, those triple-digits will be higher than just 100. If we need to use more traditional investment grade corporates it will be on the lower side. But we think, we have always said, we think this is a kind of a 90 to 110 basis point business. In the current environment its probably a little wider than that. That's what we saw in the first quarter, but it really depends on how we shift around our asset mix and what access to funding we have as we replace these contracts.

Mark Finkelstein - FPK

Okay, great. And then on the debt extinguishment costs that are continue to be in guidance, sorry if you addressed this already, I guess can you just give us an update on the status of that, I guess of that securitization and what would be the impact excluding the $0.07 charge, if that ultimately was not an FY08 event?

John D. Johns - Chairman, President, and Chief Executive Officer

Mark, this is Johnny. We're making good progress on our securitization plans. We've identified number of different options and we are just sorting through them. But I think we are getting pretty close to moving ahead with our preferred options. If we don't close out a new securitization program this year, there will be some increase in funding, a cost under the existing facility but its not that material too as we don't see that as being really a driver towards our earnings goals without any real consequence. And to the extent we do securitize under niche structure. It is going to be somewhat more extensive but again we think sort of inline with what we can accommodate within our product pricing structures. We still get our returns. We still be competitive and we can still pay the cost of securitization and actually I'm hopeful that the ultimate cost if this market settles down of securitization is inside of that which we included in the financial projections that we displayed at the March Investors Conference.

Mark Finkelstein - FPK

Okay. And then on the life marketing segment, can you just comment, sorry if you addressed this as well, can you just comment on whether the drop in the expense line in that current level is sustainable or were there kind of anomalies in there and we shouldn't kind of take that sub 10 million as a run rate going forward?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

I think, Mark, we think the expense reductions are sustainable. We probably had a little bit of one time positive in the first quarter also, so I'd probably say that the net impact of the first quarter earnings was about $2 billion related to the expense reduction if you want to kind of look at that and we believe... that's one of the reasons that we commented, we think the run rates are healthier as we see the higher yields in our expense reductions going forward.

Mark Finkelstein - FPK

Okay, great. Thank you.

John D. Johns - Chairman, President, and Chief Executive Officer

I think it's after the hour now, so a couple more questions and then we will available for any people want us to fill any of the details in.

Operator

Okay. We'll take our next question from Jukka Lipponen of KBW.

Jukka Lipponen - Keefe, Bruyette and Woods

Good morning. Two questions, first of all, how do you yourselves view your run rate of earnings at this point?

John D. Johns - Chairman, President, and Chief Executive Officer

I think what we viewed is about... between $0.95 and $1 a quarter, I think.

Richard J. Bielen - Vice Chairman and Chief Financial Officer

I think... we think if you added back the fair value items which would get us to about $0.97 that the quarter was very reflective of what we think the underlying run rate was, as we go through all the little pluses and minuses.

Jukka Lipponen - Keefe, Bruyette and Woods

And secondly the euro sales in the quarter, how did those track against your own expectations?

John D. Johns - Chairman, President, and Chief Executive Officer

They were about in line with our expectations. Again because our plan for the year really revolves around, the new products that we just introduced recently and we will introduce in the next few weeks, pretty much in line with our expectations.

Jukka Lipponen - Keefe, Bruyette and Woods

Thank you.

John D. Johns - Chairman, President, and Chief Executive Officer

Thank you.

Operator

We'll take our last question today from Eric Berg at Lehman Brothers.

Eric Berg - Lehman Brothers

Thanks very much and good morning. Just a couple of questions, I know we want to finish up here so, try to be concise. Rich, can we go back to Ed's question, and see the goal if it would be okay. The different factors you consider in forecasting the value of this portfolio in the corporate area and why again, I know you got over this, but I'm still struggling here and maybe we need to take it offline, again why if it is not in FO [ph] it is highly likely that this market is going to come back. Could you mind reviewing that one more time please?

Richard J. Bielen - Vice Chairman and Chief Financial Officer

Okay. I'm going to handle it slightly different. So if, you look at the market yield on the assets that are in place and the related hedges and funding cost we have a portfolio of roughly $400 million and that net spread differential between the yield and the funding cost is about 400 basis points. So if you take 400 basis points on 400 million that's $16 million for the year or 12 million for the balance of the three quarters.

In addition to that, the assets that we have in that portfolio on average are in a price of what we $0.96 on the $1. And they have an average life of roughly three to four years. As they roll to maturity those asset should move from $0.96 to $0.97 to $0.98 as each year passes and so we have got about nine months to go, 1% times of $400 million for nine months is about $3 million. So now I have the 12 from the spread, the 3 from asset appreciation, the related swaps that we have had an unrealized loss on them of about $13 million, and they have a little less than three years to run. If you run that off for the following nine months, their value as they move back towards par will drop in value by about $4 million. So I pickup $12 million of net spread, $3 million of asset appreciation, $4 million of the related swaps that will move back towards par totaling approximately $19 million and in that are not forecasting a change in spreads, in credit spreads or anything else or change in the yield curve. I am just running them towards their natural maturity because of their relatively short duration.

Eric Berg - Lehman Brothers

Also one element I would like to follow-up, I'll do that online. My second and final question relates to the credit default swap business that you mentioned and the question is this, if you are going to the effort to analyze the state of corporate credit and are making an investment that corporate credit will do whatever you are thinking its going to do, and it goes against you, I mean, isn't this sort of an operating item? I know you recorded as a realized loss, because you are changing the value of the derivative but this is a business that Protective has decided to be in shouldn't it... why is it below the line, I guess is my question, since this was a conscious decision to be in this business?

John D. Johns - Chairman, President, and Chief Executive Officer

Eric, it is truly just a mark-to-market on a derivative contract. It doesn't qualify for pure hedge accounting on the FAS 133. And we are required under FAS 133 to bring that below the line. That's just a basic accounting rule. And in terms of what, how to think about it, we didn't actually exchange any cash, that we paid out one price and we realized another price which resulted in a cash loss of 90 from the mark-to-markets almost credit to false swaps. And as Rich and Carl indicated, we have already closed out positions since the end of the quarter, in which Carl I think, we've realized 15, I am sorry...

Carl S. Thigpen - Executive Vice President and Chief Investment Officer

It's about 8 million.

John D. Johns - Chairman, President, and Chief Executive Officer

8 million. We're actually now closing with these out realizing $8 million cash gain on those that the prior March was just spreads widened mark-to-market. Now we are closing the math and realizing the cash. But again it goes below the line because that's the way FAS 133 works. It is just a requirement we have.

Eric Berg - Lehman Brothers

Thank you very much.

John D. Johns - Chairman, President, and Chief Executive Officer

Thank you. Thanks again everyone. We appreciate your time and your interest in Protective and again feel free to contact us if you have any holes in what we've presented and we [indiscernible]. Have a good day.

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Source: Protective Life Corp. Q1 2008 Earnings Call Transcript
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