MetLife, Inc. Business Update Call Transcript

Oct. 8.08 | About: MetLife, Inc. (MET)

MetLife, Inc. (NYSE:MET)

Business Update Call

October 8, 2008 8:00 am ET

Executives

David M. Platter - Credit Suisse

Conor Murphy - Director of Investor Relations

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

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

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

Analysts

Colin Devine - Citigroup

Andrew Kligerman - UBS

Mark Finkelstein - Fox-Pitt Kelton

[Connie Devodver - The Boston Company]

Thomas Cholnoky - Goldman Sachs & Co.

[Eric Vale - T. Rowe Price]

John Nadel - Sterne, Agee & Leach

[Terri Shoo - Pioneer Methods]

Thomas Gallagher - Credit Suisse - North America

Operator

Welcome to the MetLife recent announcements. (Operator Instructions)

Before we get started I would like to read the following statement on behalf of MetLife. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws including statements relating to trends in the company’s operations and financial results and the business and the products of the company and its subsidiaries. MetLife’s actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties including those described from time to time in MetLife, Inc.’s filings with the US Securities and Exchange Commission. MetLife, Inc. specifically disclaims any obligation to update or revise any forward-looking statements whether as a result of new information, future developments or otherwise.

With that I’d like to turn the call over to David Platter of Credit Suisse.

David M. Platter

I’m David Platter with Credit Suisse and on behalf of Credit Suisse and our joint lead managers Merrill Lynch and UBS, I would like to thank you for joining this morning’s conference call with MetLife’s management team.

Earlier MetLife pre-released its third quarter 2008 results and announced that it will be offering 75 million shares of common stock for general corporate purposes and potential strategic initiatives. The common stock offering is scheduled to price today and the offering includes a customary 15% over allotment option.

Representing MetLife on today’s call are Robert Henrikson, Chief Executive Officer, and Bill Wheeler, Chief Financial Officer. Before Rob begins Conor Murphy, Director of Investor Relations for MetLife has some brief introductory remarks.

Connor Murphy

Before we begin I need to make a couple of additional disclosures. We will be discussing certain financial measures not based on Generally Accepted Accounting Principles or so-called non-GAAP measures. An explanation of how to reconcile these non-GAAP measures to the most directly comparable GAAP measures is in our press release and available on our website at www.metlife.com. 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.

As Dave said, joining us this morning are Rob Henrikson, our Chief Executive and Chairman, Bill Wheeler, our Chief Financial Officer, and we will also have Steve Kandarian, our Chief Investment Officer, available whenever we take your questions.

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

C. Robert Henrikson

Let me start out by saying that MetLife is in great shape. I know you’re probably a little surprised that Met’s raising capital but bear with me and I will quickly explain why we are doing this. Then Bill Wheeler, our CFO, will give you some color on our strong capital position and ample liquidity even before this capital raise. Then we’ll preview our third quarter results and frankly it was a decent quarter even in these difficult environments.

So why are we doing this? Well, let me give you a sense of what we’re focused on.

First, we are mindful of what’s occurring in the markets. We are obviously in an unprecedented environment with significant volatility in share prices and in credit spreads. But let’s be clear. We have a strong financial footing before any capital raise. We want to be completely transparent about that and we want to leave no doubt with anyone about the shape we are in.

Secondly, we want to be recognized as the strongest life insurance company. Right now there are tremendous opportunities for us in the market place. We are widely recognized as a well-capitalized company with a clean balance sheet. We are enjoying competitive advantage and we are benefiting from that more and more every day. We want to protect that advantage and this capital raise helps ensure that we do that.

And thirdly, as I said there are a lot of opportunities out there at the moment including significant strategic opportunities. I expect that we can put this capital to work and build tremendous shareholder value with it.

And now let me turn over the call to our CFO, Bill Wheeler.

William J. Wheeler

Let’s start with our holding company liquidity. Let me back up. I first want to talk about liquidity, then capital adequacy and then I want to review our third quarter results. So let’s start with holding company liquidity and get that out of the way.

We have a significant amount of liquid assets at our holding company, $1.75 billion at quarter end, and we expect that to increase by year end. None of our holding company long-term debt is due before 2011 so we have no roll-over risk. Our commercial paper program at the holding company is very modest and is about $300 million at September 30. We keep the program active but we do not use it for general corporate funding purposes. So our overall holding company liquidity is strong.

With respect to our insurance businesses, our retail and institutional businesses have different liquidity characteristics. In our retail businesses, which includes our individual life and annuity products, we have lapses and surrenders in the normal course of business in many areas. These are reasonably easy to estimate and predict and in fact our lapse rates have been decreasing year-over-year.

Turning to our institutional retirement and savings business, which is I think an area of focus for people, we have current account values at September 30 of approximately $96 billion. About $92 billion of that is comprised of pension closeouts and other fixed annuities without surrender or withdrawal options. We also have global GICs in that number which have stayed at maturity and cannot be put to us early. As a result there is no liquidity risk in this part of the portfolio.

With regard to retirement and savings liabilities where customers do have limited liquidity rights, there are approximately $4 billion in funding agreements which can be put to us after a period of notice. While the notice requirements vary, the shortest notice period is 90 days and that applies to only $1 billion of these liabilities. The remainder of the notice periods are between six and 13 months so even on the portion of the portfolio where there could be liquidity pressure, it is clearly limited.

With respect to ratings downgrade triggers, a very modest amount, less than a billion, of the retirement and savings liabilities are subject to triggers and even a two-notch downgrade would impact our derivative collateral requirements by less than $200 million. So we don’t have any notable exposure to any ratings dependent liquidity factors.

Many investors have asked us about our securities lending business. Just to remind you how this works, we lend various types of fixed income securities in return for cash collateral which we invest in high quality assets. At the end of the second quarter our loan book was $45 billion. At September 30 it had declined to $41 billion. Of this $41 billion about $15 billion is open, which means that the securities can be returned to us overnight while the remainder of the balance has varying maturities ranging from two weeks to several months. Of the $15 billion of securities on open, $10 billion are treasury and agency securities which if put to us can be immediately sold to satisfy the cash requirements.

Should liquidity needs accelerate here, we have a pool of $9 billion in cash dedicated to meet these needs and in addition we have the liquidity resources of most of MetLife’s general account at our disposal.

For MetLife overall our cash and cash equivalents position is up from $14 billion at the end of the second quarter to $21 billion at September 30. So I’ve given you a sense of our liquidity positions and we think our liquidity is well in hand.

Turning to a discussion of capital adequacy, one of the key metrics on which we are evaluated is risk-based capital. We manage to a high 300 RBC ratio and believe a ratio around 350 is appropriate for an AA financial strength rating.

Even after our third quarter results, which were good, we believe our statutory cushion above 350 is in excess of $2 billion at our insurance companies. There is an additional $1 billion at the holding company that we could downstream if necessary and another $1 billion coming to us in February through the second half of our mandatory conversion. Totaling that up, I believe that our capital cushion is in excess of $4 billion today. Obviously the equity we raise from this transaction represents additional capital.

Let’s move on to our preliminary third quarter results. It was a respectable quarter in a difficult environment. Our top line revenues which we define as premiums, fees and other revenues were $8.6 billion this quarter, an increase of 16% over the third quarter of 2007 and year-to-date these revenues are up 12% over the first nine months of ’07, so our revenue growth is strong.

We anticipate that income from continuing operations for the third quarter of 2008 will be between $1,005,000 and $1,150,000 or $1.38 to $1.58 per diluted common share. Operating earnings for the third quarter of 2008 are expected to be between $600 million and $675 million or $0.83 to $0.93 per share.

Let me highlight some of the preliminary key elements that are reflected in this operating income range. First of all, it should come as no surprise that this was a challenging quarter for variable investment income. Our shortfall versus our plan which is approximately $117 million after tax or $0.16 per share was driven mostly by negative returns in hedge funds and private equities.

Also it is no surprise that variable annuity revenues and DAC amortization were impacted by lower equity markets. The almost 9% decline in the S&P500 in the quarter impacted us by approximately $105 million or $0.14 per share. By the way our variable annuity hedging continues to operate as intended.

We accrued approximately $48 million or $0.07 per share related to the first phase of the company’s operational excellence initiative which you’ve heard about previously. The third quarter accrual largely relates to severance of employees who will be leaving around year end and we expect this action will result in annualized savings of about $130 million pre-tax.

Our operational excellent plans extend through 2010 and while we will incur additional costs, we expect that they will provide future cost savings of at least $400 million pre-tax per annum as well as revenue enhancements. We will provide you with more details around this at our Investor Day in December.

Also this quarter MetLife announced a decision to commute its excess insurance policies for asbestos related claims, which amounted to a $23 million reduction in operating earnings or $0.03 per share.

As you know, during the quarter MetLife completed its split-off of substantially all of the company’s 52% interest in RGA. As a result our share of the operating earnings of RGA in the third quarter, approximately $24 million or $0.03 per share, is now reflected in discontinued operations while previous periods will be re-classed in discontinued operations when we formally report our third quarter numbers. The split-off transaction results in a GAAP loss of $460 million, a statutory gain in excess of $1 billion, and a decrease in MetLife’s share count of approximately 23 million shares.

Now let’s talk about investments. Our general account investment portfolio stands at $324 billion with an average rating of A. We have a high quality credit portfolio with reduced exposure to recession-prone sectors. Our structured finance portfolio has performed well and incurred few losses. And our real estate and direct mortgage portfolio is of high quality with low average loan-to-values. Obviously we have discussed the strength of our investment portfolio with you many times and that has not changed in the third quarter.

For the quarter we expect net realized investment gains after income tax to be between $400 million and $475 million. Included in these gains are approximately $490 million net of tax in credit related losses including impairments. Approximately $375 million or 77% of these losses are related to major financial services credit such as Lehman, Washington Mutual and AIG. These losses were offset by derivative gains of approximately $735 million after tax, which arose primarily from the increase in value of the US dollar in the third quarter as well as the increase in MetLife’s credit default spread.

As of September 30 our shareholders’ equity excluding accumulated other comprehensive income or AOCI is approximately $35 billion. AOCI is -$7 billion after tax. Consequently our book value per share including AOCI is approximately $36 and excluding AOCI is approximately $46.

Before I close I want to make a couple of other points. I think you will appreciate that given the current volatility, I don’t think I can provide you with a meaningful estimate of our fourth quarter earnings. I don’t want anybody to read too much into that. Our revenue growth is strong and our core businesses are performing well. I’ve shown I’m not very good at predicting the performance of the stock market or the performance of alternative asset classes. I’d rather not make that mistake again in the fourth quarter. It’s that volatility that we can’t predict that causes us to not estimate. Underlying insurance growth and profitability is good.

Similarly, it is difficult to predict right now what impact the current environment will have on our 2009 earnings. We will obviously give you an update as well as our 2009 plan at our Investor Day on December 8, which is when we normally do it.

We still intend to have our normal third quarter earnings release as scheduled on October 29.

Before I turn it over for questions, let me just summarize. The fundamentals of our business remain strong. Despite the market environment we continue to benefit from our mix of complementary businesses. We are being proactive to ensure all of our stakeholders how financially sound we are. We are enjoying significant competitive advantages as Rob mentioned from being strong and we are poised to take advantage of some unprecedented opportunities available to build shareholder value.

We’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Colin Devine - Citigroup.

Colin Devine - Citigroup

I was wondering if you could provide a little more guidance on securities lending. If markets stayed locked where we are today, what would that do to your earnings next year in terms of looking at securities lending? And also tied to that can you confirm in the third quarter you made money from it, you just made less money.

William J. Wheeler

That’s right. Well, third quarter securities lending performance was actually pretty good even though obviously the end of the quarter got a little volatile. In terms of the outlook for securities lending, I think it’s safe to say we assume that the overall outstandings will probably shrink. How much it shrinks is very difficult to say.

In terms of margins, it’s funny. In some ways this is a great environment for sec lending margins and in other ways it’s difficult. It’s hard to really predict what’s going to happen to the short-term interest rate or these relative LIBOR or fed funds rates and stuff like that. Obviously we had a fed rate cut this morning. So margins on sec lending have been very good. They probably will decline some but they’ll probably still be okay. But clearly the balances I think are going to come down here for a while so that will have an impact on our earnings power next year.

Colin Devine - Citigroup

I think what everybody’s been very unsettled about is how much is this adding to Met’s earnings? What is the range that you’re generating on the sec line?

William J. Wheeler

Obviously we get asked that occasionally. We don’t disclose it. We do make good money from sec lending so it is going to have some impact on us. But I don’t think it’s dramatic and I think on the margin it’ll affect us a little bit but it won’t be significant.

Operator

Our next question comes from Andrew Kligerman - UBS.

Andrew Kligerman - UBS

I’m just thinking about this capital raise and I’ve got two thoughts and I want you to tell me which way to think about it. You started the second quarter or you ended the second quarter with $4 billion in excess capital, and that’s probably relatively the most in whole life space.

When MetLife comes out and asks for new capital, it makes me wonder if MetLife is scared because the indications were that they would be the last company that needs it. And then on the flip side of the equation, could Met be doing a deal? Could it be looking at AIG’s assets? Could it be looking at something else? And I think about J.P. Morgan when they did WaMu, they raised capital upon the announcement. Wells Fargo, same thing with Wachovia. They do the deal and they raise the capital on the announcement. So it doesn’t seem like there’s a need to rush out and raise capital before you announce the transaction.

So the question is, give us a little comfort here. Are you really just scared? Is there something wrong that we should know about, because that’s the sense I’m getting from this capital raise? And then the second part of the question is if you’re going to do a transaction, what types of assets are you looking at? If it’s AIG, what areas are most appealing? If it’s outside of AIG, what might you be thinking about?

William J. Wheeler

I’ll let Rob respond to this as well.

C. Robert Henrikson

I was going to jump in and say, “Bill, do you want to go first or me?” We actually are in different locations so we can’t do the usual I’ll point to you and you point to me. But I’m ready, willing and able to get at that one. And I’ll just start out and maybe comment later after Bill makes comments.

I can’t emphasize enough, having been in this business as long as I have been and looking at the opportunities we’re looking at, both in terms of business that we do that we are expert in that we have very, very clear and beneficial lead. And those opportunities are real and we would like to be able to pursue them as opposed to raise capital and have the pursuance of that business dependent on the capital raise at that time.

But this is real and of course in terms of merger and acquisition activity, as I’ve said over and over again, we are unusual in the life insurance space in that there are several opportunities that are available to us because of the breadth of our business both institutional and on the retail side, and we’re enthusiastic about those opportunities. And as you know our M&A department in terms of scanning the market place in conjunction with our businesses and their strategies and tactics, we’re in that business 7x24 constantly watching, looking. We want to be knowledgeable about what’s available.

We obviously with opportunities that are coming to market now are in a position that others are not in and we want to make sure that we don’t look back on this time and say, “We were just comfortable where we are but we had missed opportunities for the shareholder that we did not pursue for various reason.” It’s about dry powder Andrew.

Andrew Kligerman - UBS

Maybe could you give us a size or a type of asset that you’re looking at? What could we expect inside of three to six months? Is there a $5 billion deal out there that could arise? Give us a size and a type?

William J. Wheeler

Andrew, maybe I’ll do that. In an open forum we’re not going to speculate about deals.

Andrew Kligerman - UBS

Right. I just want to get a color.

William J. Wheeler

Yes. I think you understand as well and I think the market understands that it’s very clear what some of the opportunities out there and some of them are bigger than $3 billion/$5 billion; they’re bigger. So this capital raise if it couldn’t pay for some of those bigger things that are out there, we’re going to look at everything. By the way, that’s what we always do. We look at everything and we want to evaluate it and see, does it fit for MetLife? Is it going to build shareholder value? So we’ll continue to be proactive about that.

I think what’s a little different now than maybe in the past is I think the number of opportunities are substantial. I know you want to get this up, but I just want to say the thing is we’re in an environment now where there’s a lot of uncertainty and a lot of customers are looking for safety and soundness. We want to be known as the company that has that safety and soundness. So that’s the environment we’re in and that’s the message we want to get across today because we think that’s going to get us a lot more business. If there was a deal at hand, we’d have to disclose that in what we’d be talking about. But I do think there are a lot of opportunities.

Andrew Kligerman - UBS

The last thing I’ll say is $4 billion of excess capital certainly to me seems safe and sound. So if you’re raising this additional potential $3 billion here, I’m going to assume then that a transaction is imminent. Should I think that? And should I think it’s soon?

William J. Wheeler

No. M&A is by its very nature opportunistic. We may have a great opportunity. We may not. But there is nothing imminent. If there was something imminent, we would tell you. We aren’t trying to be cute here. But we think there’s going to be a lot of opportunities.

Operator

Our next question comes from Mark Finkelstein - Fox-Pitt Kelton.

Mark Finkelstein - Fox-Pitt Kelton

Can you just talk about the equity market sensitivity to statutory capital from these levels? I’m just kind of curious if you had another 10% decline, what does that do to my C3 Phase 2 calculation? What’s the statutory strain from that scenario? And maybe looking at it the other way, if we get some recovery? Because I’m just thinking about stat capital levels and trying to reconcile some numbers?

William J. Wheeler

Sure. C3 Phase 2 I think it’s probably actually VA CRVM that will have the biggest impact on stat capital adequacy. By the way, this is insurance code I’m speaking here.

We have to do statutory calculations once a year to a bunch of [stataskik] models for some of our insurance liabilities to kind of figure out what statutory liability we should post, and that impacts our RVC ratio. And we do [stataskik] models around interest rates and then potentially VA CRVM in the future which is really about equities. You have to realize now our equity exposure in our company, almost all of it is in our variable annuity business. Almost all of it, not all of it. So the way our hedging program works and because we think it works quite well, it causes a big offset to any of that.

So I hesitate to give you a number because I’ll be honest, it’s sometimes hard to give you an easy rule of thumb for a [stataskik] modeling program. But we don’t expect the impact of things like VA CRVM or C3 Phase 2 to have a very material impact on our RVC ratio, and the reason in the case of equities is because of the hedging we do. And the hedging we do, which is obviously not dynamic, it’s sort of static, allows us to have that offset.

Mark Finkelstein - Fox-Pitt Kelton

How does the $1 billion statutory gain that you talked about on the RGA transaction, is that part of the $2 billion stat excess capital level?

William J. Wheeler

Yes, a piece of it is. Remember now we did this transaction so we realized a very big stat gain and then as part of that we actually dividend the shares up from the insurance companies where they were held up to the holding company and then we did the split. So we recognized the big stat gain and then effectively sort of did a dividend.

The net of all that believe it or not is still actually a positive impact on RVC even though it’s not the full bill because of the capital we have to hold against that equity position. It’s complicated but the full bill, most of that value actually then got given up to the holding company for the split-off. But there is some additional benefit which is in the $2 billion excess.

Operator

Our next question comes from [Connie Devodver - The Boston Company].

[Connie Devodver - The Boston Company]

I hate to beat a dead horse but I guess I just wanted to get more clarity on as far as the timing of the deal, I know Andrew had asked about why go out and raise this before a deal is announced. And I certainly agree with you that there are a lot of opportunities available on the market, but I would definitely like to get some comfort as to why this is being done before versus after.

William J. Wheeler

I want to reinforce the idea that this is more than just building a war chest to do an M&A deal. This is about being the leader in this industry and projecting a source of strength, and as Rob I think alluded to that’s going to help our regular insurance businesses. This is an environment where, think about banks, people are really distinguishing now between safety and soundness more than I think they ever have. And that’s occurring in the insurance industry as well. So we want to make sure that we’re seen as the safest place to do business. So that’s a lot of what this is. If some of this money does get used for a transaction, that’s great and that’s opportunistic. But that’s secondary. I’m not necessarily just trying to build a war chest.

[Connie Devodver - The Boston Company]

As far as when I think about deal sizes, if you play it out it could be anywhere from $3 billion to $5+ billion, and that means you could probably fund it with this capital raise plus your excess capital, but some of the opportunities might be bigger. I’m just trying to handicap the possibility of another capital raise if a deal does get announced.

William J. Wheeler

I think you’ve figured it out as you talked it through. I think if there were a bigger deal that we found really attractive and accretive that will clearly build a lot of shareholder value, we would have to do some other financing. Whether that means another public equity raise or not, I hate to speculate right now. You just have to see. Again it’s going to be very situational. There is no deal in the works. I want to make sure people understand that.

C. Robert Henrikson

Remember, I would just mention for color too, and I’m trying to think of how we’ve helped to clarify things in the past about some of our normal commercial business activities. Some of the deals we have available to us for example on the institutional side I’ve always likened more to acquisitions.

[Connie Devodver - The Boston Company]

As far as when you’re thinking about debt capacity, let’s say if there’s a larger deal that does come up, can you just walk us through other sources of funding? I mean I kind of assumed the hybrid market is shut down but the debt market, if that would be a possibility? And then secondly, just remind us what your acquisition criteria is, whether it’s an accretion or IRR target please?

William J. Wheeler

The capital markets are so volatile you kind of have to say right now that yes the hybrid market’s shut down but a month from now it could be opened again. The debt markets aren’t great right now because obviously spreads are wide but that could change. We obviously have a lot of flexibility we think in terms of how we might finance deals and its going to be very fluid in terms of how we look at deals.

In terms of financing criteria, I think in this environment you have to be thinking about that unless it’s a very unusual property that it’s accretive immediately. Frankly we don’t look at just any one thing. We don’t have just one rule of thumb. We look at IRRs because of cash flows in terms of we always want to make sure a deal has a 15% return as a general rule of thumb, but we also look at GAAP EPS accretion, we want to make sure that that’s a good number.

And by the way, sometimes given the vague reason how things work those aren’t necessarily always the same. A good IRR deal sometimes isn’t GAAP accretive but we want to look at both. So we don’t have just one test. We evaluate deals on a lot of different bases.

[Connie Devodver - The Boston Company]

I’ll follow up off line later.

Operator

Our next question comes from Thomas Cholnoky - Goldman Sachs & Co.

Thomas Cholnoky - Goldman Sachs & Co.

In this current market environment are you changing at all how you define a capital cushion or an adequate capital cushion? And I guess what I’m referring to is that Hartford when they raised capital obviously talked about a stronger capital cushion and perhaps raising that bar. Is that something that we should think about?

William J. Wheeler

It’s interesting. I’m not smart enough to know what the appropriate capital cushion is. Again you kind of judge in terms of $4 billion’s not good anymore, now it needs to be $6 billion or something like that. It’s hard for me to gauge about what’s the right number. For us we’ve tried to be as transparent as we can with the facts in this call so you guys can judge as well as we can whether you think $4 billion is enough. I certainly think $4 billion is enough.

But I also think that we’re in an environment where just math sometimes isn’t all that’s going on here and we want to make sure that people really believe that Met’s there and it’s always going to be there no matter what their concerns are of some sort of worst case scenario. So that’s sort of the image we’re trying to project.

I’ve been doing this a long time, I’ve been in this industry, and I’ve been following this industry for a long time. The opportunities that are in front of us right now are as strong as they have ever been I think. Rob’s been in this business even longer than I have. It’s not a common [inaudible]. But when I look at the transaction opportunities that are out there, this is as interesting as it gets.

Thomas Cholnoky - Goldman Sachs & Co.

Just on the capital position. One of the things that jumped out to me was the big jump in unrealized losses which I think were mostly price driven as opposed to credit. How much should we worry that those unrealized losses will actually turn into impairments given where other financial institutions have been marking some of these topical assets and versus where you are today? And how much of a risk is there that this incremental capital that you raise will simply get eaten up by impairments that you may have to take in future quarters?

C. Robert Henrikson

The unrealized losses, they’ve grown and a lot of that increase occurred frankly in September with the increase in credit spreads and the market volatility.

Something you always have to keep in mind is for every asset there’s a liability and that liability too is just a series of cash flows. So as interest rates move around, the discount rate on that set of cash flows changes as well. But we don’t do that mark-to-market in GAAP accounting so that’s always important. So if you see the value of the assets decrease because of higher interest rates, same thing with the liabilities; they do the same thing obviously. But we don’t do that offset in GAAP. The fact that unrealized losses went up really as you said driven by a change of interest rates, I don’t think anybody should be too alarmed by that in and of itself.

I think what you have to look at again are, what really is going on with credit and are there really going to be big credit losses?

You saw the impairments we took this quarter, which I think frankly were not small but I think were very manageable in what was a pretty crummy quarter in an industry where we have a lot of exposure. So I think we dealt with that problem pretty well. It gives you a feel for how big a problem this might be for us in the future.

I think the other thing you could point to is if you look at, and I think we’ve disclosed this, are the amount of unrealized losses we have whether it’s more than a 20% higher cut and they’re aged for more than six months. I think the analyst community often likes to look at that number to see what’s really maybe credit driven as opposed to just interest rate driven. And that number is about $1.7 billion pre-tax.

We actually have looked at every security in that bucket and we feel that through our impairment process we think those are money good and we don’t think they need to be impaired. But that sort of gives you a signal for the size of stuff with it driven more by credit than it is just by interest rates. Now $1.7 billion, and obviously we’re earning money every quarter, is relative to our capital cushion and the fact that we’re continuing to grow and make more money is a very manageable number.

Thomas Cholnoky - Goldman Sachs & Co.

Was any of what was going on in the market place at all hurting your institutional business in terms of what was happening in terms of just the volatility in the markets and what was happening with your stock price? Were any of your institutional customers getting nervous at all?

C. Robert Henrikson

No. Actually it was the opposite. In the so-called sophisticated institutional market place you have for example different kinds of arrangements out there that have been provided by other companies that we certainly now with hindsight I think it’s smart that we didn’t follow those particular procedures, so the institutional buyer who finds themselves in that kind of arrangement is looking to come home to a more stable and easy to understand and explain environment for their pension plans and for their retiree life funding and their [colees] and so forth and so on. So no, quite the opposite.

And one of the reasons I think you see the numbers lag a little bit but our growth in revenue which is obvious is somewhat reflective of that flight to quality by the institutional investor. So it’s actually helping our business and that’s part of the big opportunity that I talked about, not only revisions and extensions and growth from existing clients but also prospective clients who are very much in the middle of making decisions about how they’re going to fund and finance some of the liabilities on their books. And we are happy to say we’re very much in discussions with them.

Operator

Our next question comes from [Eric Vale - T. Rowe Price].

[Eric Vale - T. Rowe Price]

This question is for Steve. Can you walk us through the $10 billion in unrealized losses to $17 billion by category with some level of specificity so that we can try and understand where you’re marking the balance sheet now, and in particularly I would ask how much of a mark did you incrementally add on your $18 billion in CMBS, on your $4.8 billion in Alt A, and on your $16 billion in below investment grade corporate?

Steven A. Kandarian

I don’t have all those breakouts right here with me. I can tell you about the spreads that drive that number. And this is all obviously public data. If you look at the change in spreads between the second quarter and third quarter of this year, you seem some pretty dramatic moves really across the board. For example, single A bonds going up 200 basis points in spreads in the quarter. You see high yield going up 246 basis points in the quarter, bank loans 235 basis points in the quarter, and so on. These are the kinds of movements and spreads that are driving those numbers up from the $10 billion to the $17 billion in unrealized losses.

And the question that gets begged is, is that a precursor to larger amounts of defaults down the road? We’ve been concerned about this for a period of time. If you look back at the statements we’ve made in the past we have said that we are concerned about where we are in the credit cycle and not being paid for risk and so forth.

We have positioned the portfolio in a way that has moved away from the most vulnerable sectors in this kind of an economy; so for example, away from cyclicals into things like pharmaceutical and food related companies where we think the consumer’s likely to spend its dollars in those areas and result in less pressure on those kinds of companies bonds. So in the case of structured finance securities we’ve moved away from things that were riskier to things we thought were much safer including AAA rated RMBS securities that have government backing now that’s explicit that one time was implicit.

So we’ve done a number of things in the portfolio over time to try to position it for this kind of an environment. But I will tell you that as much as we were concerned about the environment, the recent situation in our economy was beyond our expectations, I guess beyond most people’s expectations. So this has been certainly more volatile than even we anticipated and I think we were one of the more negative prognosticators on the economy for quite some time in our sector. We are in these unprecedented times as Rob and Bill have mentioned. I think we’re about as well positioned as anyone in our industry for these times but we are not immune, nor are any other of our peers.

[Eric Vale - T. Rowe Price]

Just to follow up on that then since you can’t give me specificity by asset category, can you just take the $7 billion increase in unrealized losses and give us a sense for how much of that was absolute rate change driven and how much of that was spread widening driven?

Steven A. Kandarian

It’s all spread widening.

[Eric Vale - T. Rowe Price]

So if we just then think forward here, that number becomes sort of the pipeline for the $1.7 billion that you provided Bill of down 20% in over six months. Is that fair?

Steven A. Kandarian

The spreads stay wide for extended periods of time or roll over from being three months to six months, from six months to nine months, and so on. So the big question for all of us in the investment world right now is, how long does this environment remain the way it is?

And obviously a lot of people are working hard in Washington and elsewhere trying to stabilize these markets so they go back to some more normalized risk premiums. And we went from an environment in sort of the 2006, early 2007 period where risk spreads were at historical lows now to testing the historical highs and in some cases reaching historical highs. The question is, can we get this system back into some normal range?

And we’ll see how this turns out but we’re positioning the company both in terms of what we’ve done with the portfolio in the past as well as what we’re talking to you about today to withstand this kind of a shock for some extended period of time. That’s part of what we’re talking to you about today to make sure that we have an adequate cushion in an environment that we haven’t seen in this country in many, many years.

[Eric Vale - T. Rowe Price]

Did you guys buy back stock in the quarter?

William J. Wheeler

No, we didn’t. Just so it’s clear, we haven’t bought back stock since the first quarter. We did do the split-off which was a transaction that obviously has been in the works for about a year and a half. We’re actually still very happy with the split-off frankly. It was the right deal to do. But no, we haven’t been buying back any stock.

Operator

Our next question comes from John Nadel - Sterne, Agee & Leach.

John Nadel - Sterne, Agee & Leach

Maybe just to follow up a little bit on Eric’s question and sorry Steve to try and put you on the spot a little bit more and realizing that we’ll get more detail in a couple of weeks when you report the full quarter, but thinking about the move in the unrealized loss, if there’s anything more that you can help us understand, I think we all sort of see spreads widening and capping out during the quarter at various asset classes but maybe you can give us a sense for at least, what were the one or two or three key asset classes that drove the sequential increase in the gross unrealized loss?

Steven A. Kandarian

Again, as I look at the spread widening in all the different buckets of securities that we own, it is virtually across the board. The only place we really didn’t see significant spread widening was in the high call, the residential mortgage backed security bucket especially where it has now an explicit government backing. Other than that it really is every single category that we invest in, virtually all asset categories out there that have seen meaningful spread widening. If you look at the diversification of our portfolio, you can pretty much extrapolate from that and see that every one of those buckets will have had some unrealized loss increases because of this spread widening.

I’ll just reiterate now something I’ve said many times in the past, we have very little exposure to the most troublesome aspects of the residential mortgage market for example, subprime mortgages and Alt A and so on. We have first, relatively small portfolios, second extremely high quality portfolios meaning a lot of super senior high degrees of subordination kinds of securities and so on. We have not seen a big increase in terms of dollar losses in those areas.

We’re realizing more effects on a second order basis, meaning we’ve disclosed to you that some of the realized losses, the impairments we took this quarter or will be taking this quarter when we make our final announcement, relate to Lehman Brothers, Washington Mutual, AIG. So these are sort of second order effects so essentially securities that we avoided in our portfolio were held by some others whose bonds we held. So we are being impacted by these second order effects and a portfolio of our size, it’s pretty difficult to avoid all the second order effects.

We’ve done the best we can in terms of positioning ourselves to limit those exposures, but given the size of our portfolio over $340 billion we’re going to be impacted to some degree by what happens elsewhere across the board in the economy from the mortgage situation.

John Nadel - Sterne, Agee & Leach

Not included in FAS 115 is the commercial mortgage loan portfolio. Could you just give us a little color on how that’s performing during the quarter? Any increase in the valuation allowance against that on a GAAP basis? Any color there?

Steven A. Kandarian

That portfolio performs extremely well to date. We have about $36 billion in whole loans that we originate that are on our books. That’s a Q2 number. We’ll have a Q3 number later in the month when we do our earnings call. But the average loan-to-value in that portfolio is 56%. That’s end of Q2 again. All the numbers I’m going to give you right now are Q2 numbers. I don’t anticipate that number changing much or the commercial mortgage number changing much for Q3. Delinquencies are almost zero. They’re very, very small. So to date this portfolio has performed extremely well.

Having said that, we’ll see where this economy goes; we’ll see how much trickles over to other aspects of the economy; and what comfort we do have is because we have conservative loans on our books. Even if there is a failure down the road by the borrower, we do believe we still have lots of value in these properties and that we will be able to recover high percentages of our loans in these cases. I don’t have a big concern about our commercial mortgage portfolio. That’s not what I worry about.

I worry about more the general economy across the board where if we have volatility remain in this market place that spills over other financial institutions into the general economy and impacts companies across the board because the consumer pulls back and has to pull back, that’s more of the downside scenario that we try and guard against.

John Nadel - Sterne, Agee & Leach

Finally for Rob or Bill, in relation to the current environment, the pressure from the S&P, credit markets, this capital raise which is obviously a very high cost of capital, can you give us some sense obviously I’d expect that the 15% ROE objective for 2010 is off the table with maybe the caveat being if the markets were to rebound dramatically and you did some massively accretive deal maybe it’s back on the table, but in the current environment especially given what we’ve seen so far, what do you think the downside on your operating ROE is given the diversification of your businesses and some of the pressure points and the offset of expense cutting, etc? How low can ROE go?

William J. Wheeler

I probably won’t answer that very specifically because it ultimately backs into an EPS question, which I’m not really prepared to do. But you’ve got to remember here, look at the quarter for a minute. There’s this core level of underlying profitability which frankly did not change. If you look at some of our business segments, the ones that aren’t really market sensitive, and international is somewhat market sensitive but not in the same way domestic is and like auto and home, those segments had great quarters.

John Nadel - Sterne, Agee & Leach

We didn’t see that yet.

William J. Wheeler

I know you haven’t but I’m just trying to give you a little color. Those segments had great quarters. Now where we’re exposed to things like alternative asset class volatility and we do invest in those asset classes, and obviously the equity markets they obviously were weak, so if you think about the effect of those two moves which were very poor this quarter, that cost us almost $0.30 a share. So underlying core profitability here is pretty good.

If we get any kind of stability in those two areas, we’re going to do pretty well. The business isn’t really changing frankly in terms of insurance. You saw it also throughout the insurance revenue growth number. If anything, it’s odd in this environment but our revenues are accelerating. So I think I sort of feel that even though again it feels like it’s too early, and we wouldn’t normally talk about ’09 now, we feel pretty good about that. The underlying businesses are continuing to chug along. There’s some extraneous stuff that we affects us but it doesn’t affect how the overall business is doing.

Operator

Our next question comes from [Terri Shoo - Pioneer Methods].

[Terri Shoo - Pioneer Methods]

You really haven’t touched too much on the variable annuity business but you did cite in your release how you were impacted by the decline in [C haze]. You have more of an ongoing mechanism to adjust DAC. So may you can comment on that. How much of the shortfall was due to lower market levels and how much was due to higher DAC and how should we look at that? How is it that you didn’t have a larger DAC charge?

William J. Wheeler

I think you hit on it yourself. Almost all the shortfall is really, a very small portion of the impact is really reduced fees. Most of the impact is frankly accelerated DAC amortization and you explained that well. I won’t comment about others right now in terms of their accounting, but we adjust DAC every quarter based on the market’s performance that quarter. So as the market has been trending down this year, you’ve seen that show up in our annuity numbers where we’ve had accelerated DAC amortization. So the impact that we projected for this quarter, and I think I said overall it was $105 million after tax most of which obviously is accelerated DAC amortization, that’s this quarter’s impact.

[Terri Shoo - Pioneer Methods]

As we look forward when one does forecasting, I would think that when you plug in a number it would be a higher number which would impact ongoing earnings. Is that how one should look at it?

William J. Wheeler

This does also change a little bit the amortization rate of DAC going forward and then obviously you start to see the fee impact show up a little bit in later quarters. But most of the impact of a market move hits us current quarter. There are some lingering effects afterwards but most of the impact is clearly current quarter.

[Terri Shoo - Pioneer Methods]

You commented during your talk about your hedging program that it is still working pretty well. We’ve seen really tremendous market volatility, so you can talk a bit about the cost of hedging? I would think it has gone up a lot.

William J. Wheeler

The cost of hedging has gone up. Everybody obviously likes to focus on the VICs which is short term volatility. Frankly we look at sort of five-year volatility when we’re hedging, and that volatility too has gone up but not nearly as much. Frankly, not even close. So our hedging costs have gone up clearly and that does affect the profitability of the VAs a little bit but it’s not dramatic frankly because obviously there’s a lot of other sources of profits in our variable annuity business besides just riders and hedging and the hedging related to that. So the volatility spike again is long-term volatility which hasn’t been impacted as much.

When we price products, we’re obviously looking at trends over the life of the product, not just the trend of the moment. And clearly volatility’s higher. I don’t know if it’ll stay higher for the next decade because that’s certainly how long those annuities are going to be outstanding. So that’s a little bit of how you have to think about that. It does hurt us a little bit on the margin. Not that big a deal. And the underlying annuity business still makes money.

[Terri Shoo - Pioneer Methods]

Variable investment income, if you can elaborate a bit more on that, if you can refresh our memory. What was the budgeted amount? You said it’s $117 million below budget. And also I think it says it was driven by negative hedge fund and private equity returns. Can you talk about where the overall annualized returns that you’re seeing now if you look at 2008, what are you experiencing overall in terms of annualized returns on those assets?

William J. Wheeler

Our budget, and we obviously disclose this once a year when we project the next year, this year for variable investment income was $383 million a quarter. That includes not only things like LBO funds and hedge funds but also other alternative asset classes like mezz funds. It also includes prepayment fees on bonds and mortgages and it includes our sec lending profits. Most of those categories are down. Sec lending has been pretty good relative to plan.

In terms of overall returns, I’ve looked at this a little bit, there are hedge fund indices that are out there and I don’t know how much they reflect the broad market or not. It’s hard for me to tell. But our hedge fund performance is a little better than that but I think then probably the broad hedge fund performance indices if you will but it’s still negative for the year.

In terms of LBO funds, they were negative this quarter. They are modestly positive for the year. So that gives you a sense of that.

Operator

Our final question comes from Thomas Gallagher - Credit Suisse - North America.

Thomas Gallagher - Credit Suisse - North America

Bill, can you remind us what a 50 basis point Fed cut, how it affects Met?

William J. Wheeler

That helps keep down short-term interest rates. It is not an easy rule of thumb but obviously that helps improve profitability and obviously changes the valuation of some of these shorter term securities we hold.

Thomas Gallagher - Credit Suisse - North America

On a related note, when you look at the $15 billion of your securities lending that is open, that’s the overnight part of it, should we think about that as something you just let run off altogether? I just struggle with whether or not it makes any sense to even maintain that from a profitability standpoint or from a risk management standpoint.

William J. Wheeler

Those are two different issues in my mind. One is the business is still profitable so we’re going to stay in the sec lending business.

In terms of a risk management point of view, I think we gave you a lot of liquidity statistics and gave you some color on how the nature of our sec lending book is created. We think we have the risk management well in hand. So I’m not terribly worried about our ability to manage that.

I think what’s happening on the other side is some of our counterparties frankly are shrinking, which are major banks, their balance sheets, probably their prime brokers which they use securities for, activity is probably declining a little bit, so it’s probably more about them than about us in terms of the fact that this book will probably shrink a little bit. We saw that a couple months ago and have been sort of managing that way ever since by increasing liquidity to deal with it.

So that’s a little bit of the color there. The sec lending business still makes money. We think it’s an appropriate thing to do. We think we’re good at it and we think we manage it thoughtfully obviously even in this time of stress. We think it’s working well. In the long run it’s not going to go away.

Thomas Gallagher - Credit Suisse - North America

I just want to confirm, comment on whether the rating agencies were sort of behind this capital raise pushing you to raise capital or just want to confirm whether there was any role from the rating agencies in this?

C. Robert Henrikson

I want to just emphasize, I can’t emphasize enough, Bill had said that he’s been following the industry for a long time and he’s never seen anything quite like this in terms of I don’t remember his exact words but I’ll say the value of MetLife relative to decisions that our corporate plan sponsors need to make relative to decisions that individuals concerned about insuring certain risks that it’s very obvious to them that they can’t invest against these risks, they have to insure. And this provides us tremendous upswing in terms of our business, not only in expanding the business we have with a base that you know is unmatched in the business.

I can go into something that would sound more like a sales pitch and maybe that’s okay on a call like this. 90 of the Fortune 100 companies do business with us. There are a lot of people in the market place with all kinds of alternative arrangements that when everything is rocking and rolling and nobody’s feeling like there are any storms ahead, there’s the tendency to feel like there’s less risk and therefore we need to focus less on the solid balance sheets and the brand names and so forth and so on.

That is reversed. The market place recognizes our value, people are coming to us recognizing that the restrictions on certain contracts and what not obviously make sense, and it makes sense for them too as a consumer of our products and services because it is very much part of the stability of our company.

As I mentioned, again there have been historically when I look back if somebody says all the stories about insurance companies or if they get into trouble, it’s all about assets. Let me tell you something. It all starts with the liabilities. You have to understand your liabilities. The client comes to us because we understand their liabilities and we help them insure against the risks that they see in front of them.

So that presents an extremely opportunistic picture for us both with businesses we do business with now and companies that are looking to us for the first time. And this is very exciting. This is one of the reasons somebody asked me, “Are you traveling around a lot Rob?” I’m traveling around a lot, not to give speeches but to talk to people about how we can help them solve their problems. And it’s very exciting. I just can’t think of a more positively exciting time. There’s a lot of chop out there but this is a very positive time for us relative to our competition, and we intend to take advantage of it.

William J. Wheeler

I want to thank everybody for listening to this call. We’ve got a big day ahead. We’ve got a lot of work to do today. And I just want to echo Rob’s comments. This is an important time. This is a chance to really distinguish ourselves and really build value in a period where there’s a lot of uncertainty. And we intend to seize that opportunity. Thank you much everybody.

Operator

That does conclude our conference today.

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