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MetLife, Inc. (NYSE:MET)

Q2 FY08 Earnings Call

July 30, 2008, 8:00 AM ET

Executives

Conor Murphy - IR

Robert C. Henrikson - Chairman, President and CEO

Steven A. Kandarian - EVP and Chief Investment Officer

William J. Wheeler - EVP and CFO

William J. Mullaney - President, Institutional Business

William J. Toppeta - President, International

Analysts

John Hall - Wachovia Capital Markets

Eric Berg - Lehman Brothers

Randy Binner - Friedman, Billings, Ramsey & Co.

Edward Spehar - Merrill Lynch

Colin Devine - Citigroup

Suneet Kamath - Sanford C. Bernstein

Mark Finkelstein - Fox-Pitt Kelton

Steven Schwartz - Raymond James & Associates

Tisha Jackson - Columbia Management

Thomas Gallagher - Credit Suisse

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the MetLife Second Quarter Earnings Release Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session with instructions given at that time. [Operator Instructions]. And as a reminder, this conference is being recorded.

Before we get started, I would like to read the following statement on behalf of MetLife. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws, including statements relating to trends in the company's operations and financial results, and the business and the products of the company and its subsidiaries.

MetLife's actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties, including those described from time-to-time in MetLife, Inc.'s filings with the US Securities and Exchange Commission. MetLife Incorporated specifically disclaims any obligation to update or revise any forward-looking statement whether as a result of new information, future developments or otherwise.

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

Conor Murphy - Investor Relations

Thank you, Julie. Good morning, everyone. Welcome to MetLife's second quarter 2008 earnings call. We are delighted to be here this morning to talk about our results for the quarter. We will be discussing certain financial measures not based on generally accepted accounting principles, so-called non-GAAP measures. We have reconciled these non-GAAP measures to the most directly comparable GAAP measures in our earnings press release and in our quarterly financial supplement, both of which are available on our website at MetLife.com, on our Investor Relations page.

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

Joining me this morning on the call are Rob Henrikson, our Chairman and Chief Executive Officer; Steve Kandarian, our Chief Investment Officer; and Bill Wheeler, our Chief Financial Officer.

After our brief prepared comments, we will take your questions. Here with us today to participate in the discussion are Bill Mullaney, President of our Institutional businesses; Lisa Weber, President of Individual; Bill Toppeta, President of International, and Bill Moore, President of Auto and Home.

With that, I would like to turn the call over to Rob.

Robert C. Henrikson - Chairman, President and Chief Executive Officer

Thank you, Conor and good morning everyone. During the second quarter, MetLife increased its top line results by 10%, as premium fees and other revenues reached a record $9.5 billion. We also generated $942 million in operating earnings. Despite weakness in the credit and equity markets, our balance sheet continues to demonstrate its strength. Our portfolio remains well position and I am pleased with this performance.

MetLife's strong capital position is substantial, and our book value has grown to $46.51 per share. The fundamentals of our business are strong, and I'd like to highlight a few examples. In institutional, we had a strong across the board top line growth. Premium fees and other revenues in group life rose 8%. Looking at non-medical health, our top line increased 14% driven mainly by organic growth especially in dental.

Turning to retirement and savings, we continued to see significant activity in the pension close-out space, as we secured new business in both the U.S and the U.K in the second quarter.

In individual business, variable annuity deposits were up from first quarter level. We also saw strong positive net flows in the second quarter. Given the challenging equity markets, we are pleased with our variable annuity performance this quarter.

In terms of our life products, sales were up slightly as compared with the second quarter of 2007. We are seeing strong interest in our newly launched universal life product, and we continue to benefit from the broad reach that our multiply distribution channels provide.

In international, we had record top line results, and increased operating earnings by 26%. Our market leading positions in Latin America continued to drive significant growth, in our international business. In Mexico and Brazil, we added several new group customers and increased year-over-year sales considerably in both countries. In Asia, we had annuity deposits of $1.4 billion in Japan, consistent with last year levels. And on May 29th, we began to distribute our VA product through the Japan posts.

While the current economic environment may remain volatile, we will continue to benefit from our diverse mix of related global businesses. Looking ahead, they will continue to serve us well as we remain disciplined, focused on our bottom line and committed to providing value for our shareholders.

Let me now turn it over to Steve Kandarian.

Steven A. Kandarian - Executive Vice President and Chief Investment Officer

Thanks, Rob. I would like to provide you with an update on our portfolio against performance of the last quarter. First, let me start with a comment on variable investment income. Pre-tax variable income was approximately $30 million lower than planned for Q2, primarily driven by lower corporate joint venture income. As I mentioned last quarter, we expect that corporate joint venture income to moderate during the remainder of the year, due to tighter credit conditions, volatile equity markets and general economic conditions.

On the other hand, income from our securities lending program outperformed plan, due to a steeper yield curve and higher spreads in the reinvestment portfolio. As of June 30th, we had approximately $44 billion of securities on loan to 12 counter parties, which were all rated A or higher. In return for these securities, we received cash which was primarily reinvested in a portfolio of fixed income securities.

Our securities lending reinvestment portfolio is somewhat more conservative than the remainder of the general account assets; with an average rating of AA minus. We anticipate maintaining the size of our program during the second half of the year and are comfortable with our holdings and the liquidity of the business.

Now, let me cover investment losses for the quarter. Gross investment losses were $346 million, of which only $48 million were credit-related sales. Write-downs this quarter were $262 million and remained modest relative to the overall size of our portfolio. Of this amount, $221 million were credit related impairments including $82 million of financial institutions, $23 million of home builders and only $12 million of subprime related holdings.

The non-credit related write-downs of $41 million consisted of impairments of common stock holdings; the vast majority of which were held in the close block. When added together, total credit-related losses from sales and write-downs were $269 million before tax or $175 million after tax.

Unrealized losses for fixed maturities increased by just under $1 billion in the quarter to $9.7 billion, versus the first quarter 2008. While spreads generally declined from the end of the first quarter, interest rates rose across most of the curve, leading to higher unrealized losses. While the impact of interest rates changes on our assets is reflected in other comprehensive income on our balance sheet, the corresponding impact on liabilities is not reflected on our financial statements.

Next, I would like to review with you our impairment process. Each quarter, our asset write down committee which oversees MetLife's investment impairment process, determines which assets will be impaired. We consider a wide range of factors in evaluating the cause of the decline in the estimated fair value of the security, and in accessing the prospects for near term recovery. The factors we consider in the impairment process include the length of time and extent of the unrealized loss, the financial condition of the issuer and whether we received and believe we will continue to receive all anticipated cash flows. We also consider our ability and intent to hold the security, until its value recovers to book value. If we believe it is likely that we will not collect all future contractual cash flows, or if we do not have the ability and intend to hold the security until recovery, the asset is impaired, and the loss flows through our income statement.

Finally, let me discuss our credit portfolio. As we've mentioned in the past, we've had concerns about the corporate credit environment for sometime. Accordingly, we reduced our allocation to BBB credit from 15% to 13.8% of the managed assets between September 30th, 2007 and June 30th, 2008. Similarly, we've reduced our low investment grade credit from 5.7% to 4.7% of managed assets during the same period.

In conclusion, we believe our fundamental analysis, proactive portfolio management and risk management efforts have positioned us well for the current economic environment.

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

William J. Wheeler - Executive Vice President and Chief Financial Officer

Thanks, Steve and good morning everybody. MetLife reported $1.30 of operating earnings per share, a 24% decline from the second quarter of 2007. As I go through the quarter's results with you this morning, you will see that the fundamentals of MetLife's business are strong. However, our results this quarter do reflect the continued decline of the equity markets, higher implying catastrophes and certain one-time items that occurred during the quarter.

Let me begin with top line revenues, which we define as premium fees and other income. Top line revenues were $9.5 billion this quarter, an increase of 10% over the second quarter of 2007. Year-to-date, revenues are up 10.8% for the first six months of... over the first six months of 2007, which is excellent.

In international, top line revenues increased 19% over the prior year quarter to $1.2 billion. Changes in foreign exchange rates positively affected revenue growth by approximately 4 points. International revenue growth was driven largely by strong performance in both the Latin America and Asia Pacific regions.

In institutional, top line revenue growth of 16% over the year ago a period was driven by solid revenue growth across all of its major product areas. High pension closeout sales during the quarter increased retirement and the savings revenue by 65% to $553 million. Non-medical health and other had a 14% increase in premium over the second quarter of 2007, driven by dental which was bolstered by a recent acquisition. Core growth in group life resulted in an increase of revenues of 8% over the year ago period.

Turning to our operating margins, let's start with our underwriting results. In institutional, our group term life mortality ratio of 91.3% was well within our target range of 91% to 95%. However, underwriting results in group life were negatively impacted by an unusually high number of large claims in our specialty product areas. The impact of these large claims were $60 million post tax, or $0.02 a share.

In non-medical health and other, group disabilities morbidity ratio of 89.7%, was quite strong and reflects relatively steady reported incidence. In retirement and savings, we made a liability adjustment on a large institutional annuity which has been in force with MetLife for more than 20 Years. The adjustment was triggered by an administrative data true up and reduced earnings by $42 million after tax, or $0.06 per share.

In the individual business, our mortality ratio was 89.8%, which is somewhat higher than normal. Although frequency levels were slightly higher than expected, most of the increase came from higher phasing of clients.

Turning to auto and home, we experienced an unusually higher level of catastrophes this quarter, resulting in a 99.5% combined ratio. Catastrophe claims were $59 million after tax higher than planned, or $0.08 per share. Partially upsetting this was a favorable prior accident year development release of $26 million after tax or $0.04 per share. The combined ratio excluding the impact of catastrophes and prior year development improved 2 points to 87.3% year-over-year. This was driven by strong core operating results in the auto line of the business.

Moving to investment spreads, with regard to variable investment income, the performances of certain variable assets classes was mixed this quarter. As Steve mentioned, private equity returns were well below plan, but securities lending income was very high. Overall, variable investment income was approximately $21 million after DAC, TAC and other offsets or $0.03 per share lower than our baseline plan. Keep in mind that in the second quarter of 2007, variable investment income was $0.18 higher than planned. So the swing between the two periods in this area is large.

As to our future outlook, we expect variable income to be below plan in the third quarter which historically has been our seasonally lowest quarter. We currently expect a rebound of variable income in the fourth quarter, but our visibility is not as great here. In addition, we are obviously being affected by the equity markets in our variable annuity and variable life businesses. We estimate that the equity market performance versus our plan reduced EPS by $0.06 this quarter.

Moving to expenses, if you recall, we were projecting an expense ratio of 28% to 29% in 2008. Our expense ratio in the second quarter was 29.4%, a little higher than guidance. This was due to higher variable annuity in life DAC amortization caused by the equity markets. I want to make sure that everyone understands, we drew up our annuity DAC balances based on the investment performance of the related separate accounts, every quarter not once a year. So adjusting for the unusually high DAC amortization this quarter, our expense ratio is within guidance and our expenses are well under control.

Turning to our bottom line results, we earned approximately $942 million in the operating income or $1.30 per share for the second quarter. With regard to investment gains and losses, in the second quarter, we had net realized investment losses of $233 million after tax. Steve just gave you a detailed explanation of what's included in that number.

Our preliminary statutory operating earnings are approximately $750 million after tax this quarter, and are $1.4 billion for the first half of 2008. Total statutory capital and surplus at June 30, is approximately $21.7 billion, which is up $1.4 billion from year-end 2007.

We are revising our earnings guidance for the year. We currently expect to report earnings for the second half of 2008 in the range of $2.88 to $3.08 per share. This projection does not include any impact from potential one-time items such as operational excellence. When added to the $2.82 that was earned on an operating basis for the first half of 2008, we expect annual earnings to be in the range of $5.70 to $5.90. Most of the reduction in earnings is driven by equity markets. But roughly 13% decline in the S&P 500 through June 30 versus the annualized 5% increase assumed in our plan is having a big impact. This factor combined with the unusual items this quarter, are causing us to revise guidance.

In summary, the fundamentals of our business are strong and we are coping well with the volatile market. And with that, let me turn it back over to Rob, to make some closing remarks.

Robert C. Henrikson - Chairman, President and Chief Executive Officer

Thank you, Bill. As we announced yesterday, MetLife is undertaking an operational excellence initiative which will help serve as the foundation for our future growth. Let me explain. Last summer, we began a strategic review of MetLife, this ongoing effort is concentrating on our strengths, opportunities and areas for improvement. The strategic review process is the part of the Board's and my focus on preserving and growing shareholder value.

We are well positioned to capitalize on the retirement income needs of baby boomers, grow our life insurance franchise and drive growth on a global basis. Despite our tremendous opportunities and achievements, I am not satisfied. MetLife intends to extend its leadership position in the financial services industry in the coming years. In order to accomplish this, we must operate with ever increasing intensity. To that end, under my direction, I created an operational excellence initiative. Since April, a team has been conducting a diagnostic review of all our operations. The team is focused on reducing complexities, leveraging our scale, improving efficiencies and increasing productivity.

This initiative begins the transformational change in the way MetLife operates, and I expect that within the next two to three years it will yield both significant revenue enhancements and cost savings. This will require investment, leadership and discipline. Because our plans are not complete, at this time we can not quantify the financial impacts of this initiative. However, we will provide more details when we announce our third quarter results in October and at our investor day meeting in December.

Throughout my career, MetLife has demonstrated a powerful capacity to get behind a bold idea and execute. In 2000, we completed the largest demutualization in U.S. history; in 2005 we completed the largest acquisition in our history. Once again, we will leverage the tremendous resources of MetLife to further transform this great company and deliver shareholder value.

Conor Murphy - Investor Relations

Thank you, Rob. Julie, let's open it up for questions.

Question And Answer

Operator

Thank you. [Operator Instructions]. We'll go to the line of John Hall with Wachovia. Please go ahead.

John Hall - Wachovia Capital Markets

Thank you. Good morning, everyone. I have a couple of questions, quick ones for Bill and then one for Rob. Bill, at the end of each year, as we look forward to earnings, you sort of do an exercise to normalize earnings and then project growth off of that normalized base. Over the last several years, it's been a matter of subtracting to get down to a normalized number. It appears that this year, we might be adding to get to a normalized number. Is that a good way to think about what the base for growth in '09 should be?

William J. Wheeler - Executive Vice President and Chief Financial Officer

Yes. I don't know if we're normalizing yet, but I mean we're probably not subtracting any more. We're... we don't as a rule, try to normalize for equity market performance, because you know it will go up and it will go down obviously. So, we don't try to adjust, but we just try to... we do try to describe and understand the impact. So if you think about the earnings revision that we had here, most of that is driven by the equity market changes. And then, but that's the separate accounts, they're at different levels and so we'll have to grow earnings from here.

So I think, one other thing I would probably say is, even with this earnings revision we're still going to have earnings growth, certainly on a normalized basis year-over-year in '08. It's not as great as it was. But the... I don't know if we are going to... I don't know if we'll add back or not, but we'll... we may not do anything

John Hall - Wachovia Capital Markets

Okay. And then can I take from your comments on DAC that there is a 0% chance that we're going to see a DAC charge in the wholesale fashion in the third quarter?

William J. Wheeler - Executive Vice President and Chief Financial Officer

Well that's certainly... just to step back from a little bit, we do... we obviously review our DAC assumptions once a year. We generally do that in the fourth quarter. But that's... what we're looking at there are things like lapse rates and withdrawals and stuff like that. We don't really true up for market and we don't... we wouldn't do a DAC unlocking for market. We do that every quarter. And so, the answer is no. We're not going to... you won't see a DAC unlocking based on market conditions in the third quarter.

John Hall - Wachovia Capital Markets

Thanks. And then Rob, I have a question for you on the operational excellence program and how it relates to the 15% ROE target that's established for 2010 is this... this program is something that will either delay achieving that target in 2010 or accelerate it?

Robert C. Henrikson - Chairman, President and Chief Executive Officer

It certainly won't delay it and it certainly will accelerate it.

John Hall - Wachovia Capital Markets

Great. Thanks very much.

Operator

Thank you. We'll go to the line of Eric Berg with Lehman Brothers. Please go ahead.

Eric Berg - Lehman Brothers

Thanks. I just had one question. you mentioned... and good morning by the way. You mentioned that there was a bit of an earnings hiccup in the specialty life insurance area, I believe on the group side, you will correct me, if it was on the individual side, what is that specialty area; what is its specific business? And I am sure you have taken a very close look at the nature of the claims to determine what might, if anything be going on? Could you just build on your comments? Thank you.

William J. Mullaney - President, Institutional Business

Sure Eric. It's Bill Mullaney and I'll comment on the specialty area because was an institutional business it's our group universal life and group variable universal life contracts which are contracts that we offer primarily to a higher paid and executive people within the corporate accounts that are our customers. And so in this particular quarter, we had a higher number of claims in excess of $1 million than we typically see on an average quarter. And as result of that, that was driving the higher mortality in that segment of our business.

Eric Berg - Lehman Brothers

Now, I'm equally interested in knowing obviously what we all want to hear from you, but you tell us what in fact is going on is that you've studied this situation thoroughly and this is a statistical anomaly and nothing more than that but --

William J. Mullaney - President, Institutional Business

Right. When we look at--

Eric Berg - Lehman Brothers

That we are not happy about.

William J. Mullaney - President, Institutional Business

When we look at this quarter compared to the prior five or six quarters, like I said, the number of high phased amount of claims was roughly double over what we've seen over that average. So we think that it's an anomaly. We think that is really specific to this quarter and not something that we would expect to happen going forward.

Eric Berg - Lehman Brothers

Thank you very much, Bill.

Operator

Thank you. We will go to line of Randy Binner with FBR please go ahead.

Randy Binner - Friedman, Billings, Ramsey & Co.

Yes. Hi, thank you, I have a question about the $0.06 that was identified... $0.06 per share that was identified as being related to market volatility in the quarter and how that relates to the rule of thumb we had for every 1% change in the S&P 500 there was a $0.01 effect. I guess the first question is, is that $0.06 is that just from how the market performed relative to plan in the second quarter or is there some of what happened in the first quarter in there? And I guess based on that, I'd be curios to know if there is a new kind of benchmark we can use for EPS relative to a 1% change in the S&P?

William J. Wheeler - Executive Vice President and Chief Financial Officer

Yes sure well, let's kind of give you some... set out some details. In the first quarter, there was almost a 10% decline in the S&P 500 and then of course and then obviously, at the same time we have an expectation that we would have a 5% annualized, but only 1.25% in the quarter returned from the S&P 500. So let's say that was... that triggered basically sort of an $0.11 swing, if you will.

Now if you think about how that gets... using the ratio of 1% decrease in the S&P 500 cause us $0.01 a share, sort of plan versus reality, and the... and so I think in the first quarter, we said that we thought that... now, the way that $0.11 gets recognized it's over the course of the year. There is, most of the impact is upfront, but some of the impact is spread out over the rest of the year, and most of that is sort of like the separate account fee income. So $0.06 occurred in the first quarter, but then it going to be an initial $0.05, $0.06 which hits the latter second... the other three quarters, if you will, so that gets spread out.

Now this quarter, we had not quite a 4% drop in the S&P 500 in the second quarter versus another expectation of another 1.25% indication, so that would say a $0.05 swing. Okay, and so... but you're now and so that too, most of that hits this quarter, but some of it gets spread out for the rest of the year and then also I had sort of the remaining first quarter effect. So if you kind of run through that math, you'd go to okay well, I get $0.05 how did you get $0.06. And this is sort of your second part of your question.

You know this relationship of a 1% change in the S&P 500 versus a 1% move in -- $0.01 move in our earnings, isn't really linear. So when we start to see a substantial deviation from our plan, which we're starting to see now, the DAC amortization actually accelerates. So I would say, right now, changes, further declines in the S&P 500 versus planned for the remainder of the year, the relationship is more like $0.015 and not $1 anymore. So, it is deteriorating a little bit, so that's a little bit why you get something like $0.06 this quarter, and not $0.05.

That said, we are all in, we think the overall earnings impact approaches $0.20. I would just bore you with the other fact here is when we built our 2008 plan, it was sort of in the fall of 2007 and almost from that very moment we printed the plan, the stock market started going down. And we didn't really factor that in the guidance because at the time, we didn't think that it wasn't big enough to deal with, but obviously that contributes as well. So, we are a full $0.20 or so, maybe even a little more below plan in terms of impact of the stock market into on our earnings, and that's what driving down the guidance. I hope I didn't confuse you on that.

Randy Binner - Friedman, Billings, Ramsey & Co.

No, that's all very helpful. So just to clarify, so this $0.06 when that's communicated is, what happens this quarter and that will be a rate as we go forward?

William J. Wheeler - Executive Vice President and Chief Financial Officer

Yeah, pretty much a rate.

Randy Binner - Friedman, Billings, Ramsey & Co.

Okay. And is it like 60% in the first quarter and then 20, I am sorry like 40%, 50% in first quarter and then lagging from there?

William J. Wheeler - Executive Vice President and Chief Financial Officer

Yes, that a good proportion.

Randy Binner - Friedman, Billings, Ramsey & Co.

Okay great. Thank you.

Operator

Thank you. Will go to line of Ed Spehar with Merrill Lynch

Edward Spehar - Merrill Lynch

Thank you. Good morning. Bill, you had made some reference to the underwriting this quarter not being as good as some prior quarters, but still being an okay quarter. I am wondering if you could just talk a little bit about, I know you have a range of expectations, but it seems like they have tended to be may be a little bit on the better end and this quarter was not. If we were more toward the better end in underwriting, do you have any sense of what kind of a per share impact we might have seen?

William J. Wheeler - Executive Vice President and Chief Financial Officer

It's hard to quantify, obviously we've talked about this $0.02 adjustment in group life, although but other our normal group term life contracts that I think earnings, I think the mortality rates, we print in the QFS of 91.7% was actually pretty good. In non-medical health, which also has a big underwriting earnings component to it, probably the results say we're just a little softer than planned may be a penny or so which we obviously don't try to normalize for. I would also say in individual, the mortality, we said the mortality was a little worse than normal. Again, we didn't try to add that back or normalize for, but that was probably worth $0.02.

Interestingly, auto and home when you kind of, as I mentioned on the call when you cut through the catastrophe losses in the reserve releases, underwriting was actually quite good. And I don't know was it a full penny good, may be not; but that sort of gives you a feel for sort of the other changes. Obviously, we earn underwriting profits in a lot of different ways at MetLife and almost always every quarter this is the kind of the great benefit of being so diverse is, almost always you have something going in one direction and something going the other and they usually balance each other out. I would say, this quarter though was probably on average just not quite as good as our normal quarter, in terms of results. So it... but we're talking of few pennies here and there.

Edward Spehar - Merrill Lynch

And how about in the RNS area, anything there to say on mortality?

William J. Wheeler - Executive Vice President and Chief Financial Officer

Well, obviously we had this reserve adjustment which isn't necessarily underwriting experience that's really... that's a data adjustment. Underwriting there otherwise was okay, I mean we certainly had better quarters, but it was okay.

Edward Spehar - Merrill Lynch

Thank you.

Operator

Thank you. We'll go to the line of Colin Devine with Citigroup Please go ahead

Colin Devine - Citigroup

Good morning. I was wondering if we could talk a little bit more on your international businesses, come up to now about 14% of earnings this quarter and really starting to ramp up. If you can give us some sense of what's going on the underneath that I appreciate it, make a lot of money in Japan I thought you got some great sales. You can talk about some of the other businesses where you are really starting to get some traction now?

William J. Toppeta - President, International

Sure Colin. It's Bill Toppeta. I would say if you look at our business, the positive results on the earnings side are pretty wide spread, certainly throughout Latin America and also mostly in most of the countries in Asia Pacific. If I take you back to investor day, we talked about four driver countries; Mexico being the biggest. And I would say, there we're outperforming what we told you back on investor day, especially in the earnings category.

In Korea, which is our second biggest, we are pretty much hitting on the plan that we told you so, we are going to be right in that range. In Chile, which was third of those countries, we are going to outstrip the plan by quite a bit, and actually Japan is the one where the earnings are probably going to be a bit below where we told you on that range, but we're making up for that in other countries. So I would say, overall based on the... on what we told you one investor day, we are glean in every category, the only category where I would say we are not glean is sales. And in that category we are positive with the exclusion of Japan, but we're going to be a little bit lower in Japan than what we thought. So I don't know if that's enough color or if you want more detail in specific places I can certainly provide it.

Colin Devine - Citigroup

That helps. I guess the other follow up is Rob has talked about getting that to 25% over the next couple of years and that M&A would be a big part of it. Are you still out there looking certainly by [indiscernible] my I think Mr. Will there that but using our gauge that still leaves in then about $1 billion worth of cash plus to do some deals here, are we going to see something there?

Robert C. Henrikson - Chairman, President and Chief Executive Officer

Don't encourage him Colin. He... obviously Bill can talk about the deal environment. He and I are both... we were both intimately involved in what's going on international. It's where... we have closed a few deals I mean they are not big ones but which kind of says we're out there looking, we're backing the Mexican foray and this little group dental business we just announced in Brazil, neither of those deals is very material, but I would say they are they kind of indicate that we're active, I don't know you would add to that Bill.

William J. Toppeta - President, International

I really wouldn't have anything to add, we are very active and we are not just we are not just sitting and waiting for deals to come for us, we are out looking for them. Having said that, I think it is fair to observe that the environment is a difficult one especially in light of the relative strength of the U.S. dollar to some of the other currencies and also some of the accounting differences between us and European competitors specifically, so we are very, very active but the environment is challenging.

Colin Devine - Citigroup

Thank you.

William J. Toppeta - President, International

Okay.

Operator

Thank you. The next question is from Suneet Kamath with Sanford Bernstein. Please go ahead.

Suneet Kamath - Sanford C. Bernstein

Thanks. Two questions. First one for Bill, on the share repurchases, I understand that you are out of the market until the RGA transaction is completed. If that's true, it just appears that capital is going to be building pretty quickly here and especially given the fact that your investment losses are really not that material. Is that going to put some pressure on your full year ROE target? And then I guess for Rob, in your opening comments you had mentioned the operational excellence and I think you said that you are not satisfied with the situation at MetLife and you could see that improve. What specifically are you looking at that made you to comment that you are not satisfied? Thanks.

William J. Wheeler - Executive Vice President and Chief Financial Officer

Suneet I'll go first. In terms of the cap to billing that's right. I mean just to kind of review the bidding here a little bit, on investor day last year, we talked about buying back $2.2 billion of stock and that broke down something like buyback enough stock to defeat the first convert conversion which is happening in August and that we estimated at the time was a $1.4 billion it doesn't... it isn't going to be that. It isn't costing us that much anymore and then $750 million on top of the additional purchases. So fast forward to now, we're... we bought back 1.25 billion of stock so far, we are now in the quiet period of the RGA split off transaction so there is not much I can say about that but obviously that has, in my mind if that transaction is completed it effectively sort of meets our buyback commitment for the year. But we have an extra billion in cash that we hadn't originally planned on.

So capital levels, so in terms of ROE targets, if you think about the buyback activity, it's actually essentially on plan for where we were, but we are instead of using cash it's RGA share. But that doesn't mean there's extra cash now that will probably end up at the holding company by year-end. And so that gives us a little more fuel to play with in future. And that obviously it will be used for a couple of different things as it gets redeployed over the next period of time. It will be used to make acquisitions may be international acquisitions or it will get used for additional buyback activity. So that's so that in my mind just... it sort of helps if you think about the long-term ROE store which is really what we're focused on in sort of the 15% target in 2010 and I think that kind of helps us to get there.

Robert C. Henrikson - Chairman, President and Chief Executive Officer

Suneet, on the word, satisfy, let me... everybody who knows me outside there are a couple of things I will comment on. I have been enthusiastic, I continue to be enthusiastic and I am never satisfied. So if you kind of put those together this is a quite a positive statement. We have... if you look at the tremendous growth that we have achieved and you look at the shift in the business opportunities we have in some areas and you realize that we have a stronger management team today than we ever have had. You put those things together and say some of our processes and some of our legacy methodologies can really be streamlined and brought up-to-date with where we are to give us the capacity to grow more rapidly in the future.

So it's one thing to be as I am enthusiastic about being number one in so many areas one, two or three in virtually everything we do so forth and so on; but I don't like being number one and winning by a nose when I feel like we could extend our lead and coming around the third quarter I don't like to look back, I like forward. And so that's what this is all about, we are very enthusiastic about it. We have obviously in looking at the diagnostics and what not, we have some very substantial opportunities and we're going to take advantage of them.

Suneet Kamath - Sanford C. Bernstein

Okay, thank you.

Operator

Thank you. The next question is from Mark Finkelstein with FPK. Please go ahead.

Mark Finkelstein - Fox-Pitt Kelton

Good morning. Couple of quick questions. Firstly, on retirement savings spreads, they came into 1.29% for the quarter obviously I think that was one of areas that was affected by variable income, but what's interesting is actually how low the crediting rate had gone. And I guess what I'm trying to get at is, if the variable income had come in online, what would have been spreads in that business, and what is the spread outlook for the reminder of the year, clearly you were more positive about that on the first quarter call.

Robert C. Henrikson - Chairman, President and Chief Executive Officer

Yes, it's... I think we just got to give you the history there, I think in on investor day we said that we thought spreads would be 115 or 130 basis point in RNS for the year. Then when they were obviously 151 in the first quarter, we said that well, do we miss that a little bit on the good side and what happened of course is so claiming income was a little better than planned in the first quarter, but also what happened was is that long... short term interest rates dropped much faster than we had originally anticipated in our plan. And there is an aspect of retirement savings where that comes into play. There is, we have some insurance liabilities which are short, which have floating rates and which, we've talked about this before.

We run a mismatch on, so when you see us deepening yield curve like we had that should widen spread. So that caused us to sort of revise our outlook for the range to just a 130 to 150 basis points you talked about. We reported 129 as you mentioned for the quarter and if you said, well if had hit plan on variable investment income and we didn't. We were affected by it in RNS. The spread would have been 144 basis points, which is just about in the middle of that range, a little above it in the middle. But that gives you a feel for it. So I think the 130 to 150 sort of range is still valid and but obviously we'll be impacted by... there is a lot of those alternative asset classes which make up variable investment income in the retirement savings investment portfolio so it's sensitive to that.

Mark Finkelstein - Fox-Pitt Kelton

Okay. And then just one other clarification going back to Suneet's question, so after the RGA split off transaction occurs, assuming it does occur, the plan is that you will hold the cash flow that you are building and you are not going to kind of go back into the market and execute more share repurchases or is that a little bit early to suggest?

Robert C. Henrikson - Chairman, President and Chief Executive Officer

Yes. I don't -- we are not I mean I guess we're not going to commit one way or another I think we just have to see how things turn out, at the end of the year and before we... and then we'll make a decision then about what we do.

William J. Wheeler - Executive Vice President and Chief Financial Officer

Obviously we look back moving just thinking about '09 for a minute couple of things are going to happen. We are going to have another, the other leg of the other half of the convertible convert in the early part of the year. Obviously, if we allow that conversion to stand without doing any thing about it, it dilutive to EPS and so obviously we would and I think, when we talked about investor day last December, I think I gave some people a little guidance that said we're not going... we're going to offset that dilution and I don't see any reason why we will still wouldn't do that, whether that means we do that at the end of this year or very early next year, something like that I am its hard to say right now. But so, we certainly have sort of the fire power, if you will, to kind of get back into the market and do cash buy backs. So it's just a matter of thinking about our timing and the situation at the time.

Mark Finkelstein - Fox-Pitt Kelton

Okay, thank you.

Operator

Thank you. The next question is from Steven Schwartz, Raymond James & Associate. Please go ahead.

Steven Schwartz - Raymond James & Associates

Hey good morning everybody. I just want to nail down one more thing on the equity market guidance, Bill. The average daily balance in the market was actually up for the quarter, it was up about 3.2%. So I am trying to reconcile the guidance vis-à-vis the market being down point-to-point. Is what you're saying? I mean are you different from other insurers in the fact that you're truing up to DAC for markets on a quarterly basis, so really the important thing here is the lack of better term to market-to-market on the DAC as opposed to where separate account balances are going or the fees on separate account balances are going?

William J. Wheeler - Executive Vice President and Chief Financial Officer

That's right, I mean the interesting think here is if you think about the impact of market on us, the DAC adjustment far outweighs the separate account fee and the separate account fee, so you are absolutely right I mean the market ran up and then it came down. So the average balances for the quarter was actually okay so separate account fees really weren't affected all that much. But when you're doing the DAC adjustments you are really looking at the endpoints because you're thinking about well given this level of separate accounts what's the future profits we are going to earn of that annuity contract.

Steven Schwartz - Raymond James & Associates

Right.

William J. Wheeler - Executive Vice President and Chief Financial Officer

So it's... so the DAC adjustment and you can see it right now in our P&L. I mean separate account year-over-year were still up 1%, so I mean that's not as much as we would like, but it's still a positive number. What's really going on is the DAC adjustments were much bigger.

Steven Schwartz - Raymond James & Associates

Okay. And that hits in the quarter as opposed to... mostly in quarter as opposed to be spreading out over time?

William J. Wheeler - Executive Vice President and Chief Financial Officer

That's right.

Steven Schwartz - Raymond James & Associates

Okay got you. Thanks.

Operator

Thank you. The next question comes from Tisha Jackson with Columbia Management. Please go ahead.

Tisha Jackson - Columbia Management

Good morning. I had a couple of questions actually for Steve Kandarian. I as hoping you could maybe give us an update on your holdings of both Alt-A and subprime and kind of where these are marked versus original cost? And then also may be kind of update us on, what's going on in your home loan portfolio, your commercial home loan portfolio and also if you can give us any details on holdings of CNBS, AAA, AA and kind of what kind of subordination those things have at this point particularly for the '06 '07 years? And then finally, how much credit card and auto asset-backed securities do you have at this point?

Steven A. Kandarian - Executive Vice President and Chief Investment Officer

Okay, I will try cover it all.

Tisha Jackson - Columbia Management

Sorry, it's a lot.

Steven A. Kandarian - Executive Vice President and Chief Investment Officer

It's a lot there. Let me kind of click them off one by one. Alt-A, we had about $5.8 billion of Alt-A last quarter, we're down to about $4.9 billion. Some of that related to sales, some relates to roll off; we have not been buying in the Alt-A market over the last quarter. And in most of our Alt-A, you may recall is super senior, which means we bought additional insurance protection, additional subordination, when we purchased the securities sometime ago. And at the time when we bought these securities, there was a very small premium to buy that super senior turn some times only one or two basis points for that insurance, that has held us in good stead. Overall our subordination, average subordination our portfolio is over 12%, which means, over 12% of actual losses must occur before tranche is impacted.

Now historically, the high watermark for losses in Alt-A is about 2.4%. Now, we do not think its going to stop there at this time because the market we believe is in a more negative position than it has been historically, but if you look at the ranges in terms of other people's projections about losses, they ranges from about 2.5% to 10%, 10% can be an outlier in the higher side for losses, and again our average subordination in the portfolio is over 12%. So as we run these impairment processes internally, we look on a security-by-security basis and determine if we think any one of these securities may eventually not pay the full amount of cash flows contractually promised to us, and to date through all of our modeling we have taken mo impairments because we believe in all cases, these securities will be money good.

Let me move on to subprime, we are down now to about I think it's a $1.8 billion of subprime. It's been kind of rolling off and the vast majority of that of course is AAA. We brought very little kind of in 2006 and beyond vintages. And what we did buy all those AAA, AA credits. So again as we look at the marketplace and model these things on in terms of impairments, we have taken very few write-downs in this area and really don't anticipate taking meaningful write-downs going forward. Again, we stress these securities are pretty hard.

So let me go back to just to show what we're doing running these models. We have made assumptions that even from this point in time, real estate prices, residential real estate prices would drop on average 25% in the United States. Beyond that, for purposes of these impairment test not that we necessarily think that that's going to happen, but we try to stress them as hard as we think is practical. Beyond that, we look at specific markets and we have assumed as much as a 40% decline in real state prices and that's in the especially overheated markets in the coasts, places like Nevada, places... certain parts of Florida and so on. So even with those extreme scenarios, we've had a write-down very few of these securities.

Let me now switch to home loans; our home loans right now, we're in about $36 billion. We've mentioned to you in the past that we have been continuing to drop the loan to value ratio of these loans that we are putting on our books. Most of what we are doing today is serving a 50% range loan to value and that's based upon our values not necessarily based upon what someone's paying for the properties, we underwrite these properties one-by-one ourselves in our real estate department. And you may recall, we have 150 people in MetLife's real state department, who create these home loans and other kinds of loans like agricultural lending and so on. So we've moved down, actually 150 is the just real estate another 100 people in agricultural lending.

We've moved down the loan to value over time and we pretty much have stayed at this very low loan to value ratio in the current marketplace. I will tell you, it is one area both agriculture lending and home loan commercial real estate that we view as an opportunity today because the CNBS market really has frozen up and some very attractive properties are coming up for refinancing or in some cases sales, not a lot of sales going on. And we are able to underwrite these loans on a basis very conservative and make very low loan to value mortgages that we create and at very, very attractive spreads, spreads we haven't seen in many years. So we actually look at this is as a real opportunity for us and this point I believe our delinquencies are something like $3 million in our entire portfolio of $36 billion, so it's virtually non-existent.

I think then you asked about CNBS, let me kind of flip a few pages here to pull that up. So our CNBS portfolio is nearly 90% AAA rated and 74% of 2005 and the earlier vintages when the underwriting was much more stringent than we saw in the 2006 and beyond period. Our unrealized loss in that portfolio is $800 million, but again as we stress that those securities in our models we think we'll see very few impairments even with an expectation that the market will drop here in terms of pricing the commercial real estate market. We do not think that commercial real estate market will drop as drastically as the residential market for a number of reasons. And I will just summarize it quickly which is the over building we saw in some earlier real estate recessions especially early 1990s did not occur this time around. And the supply demand balance is far more attractive right now than it was back in some earlier real estate recessions.

So, we are still modeling out 10% or 15% further declines in valuation there's been about 10% dip in prices in that market already. So, basically may be a 25% peak to trough kind of dip is what we are modeling out. And based upon that, we really think the portfolio is in very good shape.

Let's just go onto credit cards and auto; credit cards about $6 billion in total, auto about by $1.5 billion. We have... as these securities would have been rolled off our books in terms of maturing or in some cases in sales, the average rating on these securities has gone up for us now. It's largely... it's a way toward a AAA rated portfolio these securities. And again I would say to you that, this is an area where we are actually a buyer and while buying is the highest tranches, first pay tranches of AAA rated credit card with the strongest trust, the banks that they have these, and kind of where it's all and also the expertise to manage these trusts, because there is some flux that goes on these trusts in terms of how they can flex these credit card security they are able to have people cut off to some degree in terms of the lending limits, the borrowing limits, they can adjust interest rate and so on.

So we are sort of following the strongest players in the market place, we are buying the highest quality tranches, we are seeing historically high spreads, we stress this again the AAA rated trans area at extreme levels beyond anything that people are projecting, and still we can find a realistic scenario that says they won't be money good and given the kinds of spreads we're seeing for AAA rated assets, which is a hard place for live as an insurance company, right now, it's actually delivering very, very strong margins for us against our traditional business, we are buying these securities.

And as you might guess, the rating agencies are looking hard at these newly created structures, they are planning to do some very tough tests, the underwriting has got much better by the creator of these securities and we really think this is a good opportunity for us to buy securities in these areas. So basically, we are putting our new money is AAA rated credit cards, selectively in autos depends upon which auto companies and so on, low loan to value Ag loans and commercial real estate loans and those are sort of the main areas we will invest our money today.

Tisha Jackson - Columbia Management

Great. Thank you. And if I could just follow-up really quick, do you have any kind of CDO, CLO exposure? And then on... when, I'd like to you, your expertise in terms of when we're questioning others on kind of their home, commercial home loans, how are you calculating the loan to value and what do you think are the questions we should be asking of others in terms of to figure out whether they're being just as disciplined?

Steven A. Kandarian - Executive Vice President and Chief Investment Officer

Yes,I am told there is queue, so I may have to go quickly, let me just kind of hit at the higher level. The CDOs, our CDOs are about $1.4 billion. Of that, only $23 million is subprime, so some of the things you are reading about in the papers in terms of people selling those. CDO exposures at $0.22 from a $1, they are very different kind of securities than we hold. Ours are largely CLOs, only 2% below investment grade, well of our half is, over 80% is AA, AAA, again we stress our structures and they all come out very well in terms of being able to pay off over the course of the length of the security.

So we have a very different kind of CDO portfolio, mostly CLOs in very high quality. So from the things you are reading about, are very different kinds of securities than what we hold. With that, I think I'd turn it over back to the operator.

Tisha Jackson - Columbia Management

Thank you.

Operator

Thank you. And our final question today comes from the Tom Gallagher with Credit Suisse. Please go ahead.

Thomas Gallagher - Credit Suisse

Thanks. Just a few quick ones for Steve also. First is, can you talk a little bit about private equity and do you still think sort of the worst case scenario for returns in the current environment is low single-digit returns or is it possibly going to go negative in particular when Bill had mentioned 3Q outlook being softer is that low returns or is that potentially going negative.

And then just a follow up on Tisha's question, on just overall, I guess you're seeing very low, for example, commercial mortgage loans and corporate bonds. Are there any signs of trouble on the horizon like are your watch list loans growing or anything like that? Thanks.

Steven A. Kandarian - Executive Vice President and Chief Investment Officer

Okay. Private equity returns, those are two buckets there; one is traditional LBO funds and the other funds that are untraditional LBO funds like mez funds and so on. The LBO funds actually did go negative this quarter because of I think you may have heard from Bill, we had earlier about one large transaction that was an equity that was publicly traded on a stub basis in a Chinese bank. And so that drove the numbers negative for the quarter. We don't anticipate that for the rest of the year because that one kind of outlier instance. But we do believe that those returns will be pretty low for the rest of the year, those kinds of returns correlate strongly with the subordinate debt market as you might guess, LBO players start selling properties to each other or to the marketplace based upon financing availability to each other and in the high yield area that's still pretty tough market right now in terms of being able to acquire there, much less that what price.

So we anticipate third and fourth quarter will be weak on those LBO returns. However, as you know, variable income has a number of components and some others are balancing off and as we've mentioned to you, the securities lending portfolio correlates closely in terms of how large the profits are to the shape of the yield curve. And right now, we have very low short-term interest rates and relatively high or higher at least longer term interest rates in the near term interest rates. So the shape of that curve does have the second lending businesses offset to some degree what's going on in the private equity portfolio.

Let me go onto commercial loans next. The delinquencies are very, very small, we are not really seeing a very much of an uptick in terms of problem loans. We did have a few things out in the Midwest that concerned us, we sold those loans. Last quarter we took them to income statement, there were some losses there, we had some reserves that we adjusted. So the parts of the portfolio that most concerned us have been dealt with to date. And as of now, I don't really see much that would concern me in terms of that portfolio overall.

I would say the corporate bond portfolio is a different story and we position that by selling off of a lot of things that are more cyclical in the economy, and increased our exposure to things that do well in a downturn. Certain pharmaceuticals for example, food certain other parts of the economy that can be pretty steady in the recession, so we position the portfolios in that way, but the number of dollars we have in corporate credit is so large that if this economic situation turns into a full blown recession, then obviously we'll have some defaults in those companies over time. And that's just the way it works in our cycles from time-to-time. So I think we are as well positioned as we can reasonably be at this point in time for we are anticipating coming down the pipe. But having said that, the portfolio is I can sit here and tell you we are not going have defaults in corporate bonds where those numbers are in excess of $100 billion on our books.

Thomas Gallagher - Credit Suisse

Okay, thanks.

Robert C. Henrikson - Chairman, President and Chief Executive Officer

I think that concludes our questions today, I think we are out of time and other people have to get on the call. So thank you very much.

Operator

Thank you, ladies and gentlemen. This conference will be available for a replay after 10:00 AM today, through midnight August 8, 2008. You may access the AT&T Teleconference Replay system in any time by dialing 1800-475-6701 and entering the access code 930800. International participants dial 320-365-3844. Those numbers again are 1800-475-6701 and 320-365-3844 and enter the access code 930800. That does conclude our conference for today. Thank you for your participation and for using AT&T's Executive Teleconference. You may now disconnect.

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