Thursday, August 1, 2013

Met Life Reports And More Thoughts on SIFI

I had been thinking about the FSOC process for designating non-banks as Systemically Important Financial Institutions (SIFI) for some time, and Met Life's potential designation as a SIFI stood out to me, which led to the post.  Since they just happened to have reported their second quarter results, I thought I should go over them quickly to see how they tie to some of the points at issue.

The CEO noted that Met Life is in stage three of the process for being designated a SIFI.  He pointed out that AIG and GE Capital had spent about seven months in stage 3 before being designated as SIFI. Designation as such requires a two-thirds majority of the FSOC, including an affirmative vote from the Chair, who is the Secretary of the Treasury.  Met Life is in favor of prudential regulation of insurance companies, since they have lived under that kind of regime for their 140 year history; he does, however, want any additional layers of prudential or capital adequacy regulation to be suited to Met Life's insurance business model.

Non-GAAP operating income for the quarter was $1.624 billion, up 11%  over the prior-year period. The reported net income figure of $471 million was down dramatically compared to a reported net income of $2.264 billion in the prior-year period.  This was driven by a net derivatives loss in the current quarter of $1.69 billion ($1.1 billion after tax) compared to a net derivatives gain last year of $2.092 billion.

Met Life's derivatives portfolio exists to hedge the risks in their business lines and not as a profit center, as was the CIO at J.P. Morgan or at AIG.   About sixty percent of the derivative losses were attributable to the Americas portfolio, primarily the U.S.  The company's announced base case forecast, used for their stress tests in their 2012 10-K, showed the 10 yr Treasury rate at 2.58% at the second quarter of 2013, and it ended up at 2.6% compared to 1.69% at the end of 2012.   Average spreads on their product portfolio were projected to be 200-250 bp, and they ended the quarter at 244 bp.  Overall, there's nothing in their near-term performance versus outlook which suggests unanticipated risk in the next year or so.

Book value per share, excluding accumulated other comprehensive income and using actual shares outstanding, was $47.20 and $46.77 using the diluted share count. Overall the stock looks fairly valued on its outlook, and to their credit the management suggested that share buybacks were not a high priority in near-term plans for returning capital to shareholders. Most buyback programs, particularly in the tech sectors are sops to Wall Street and destructive of value.  Kudos to the CEO for stating his position clearly.

Overall, all of the business segments performed well, and as planned sales of variable annuity products dropped 40% over the prior-year period to $2.8 billion in the quarter, since this business is not a productive user of capital.

One small item, from the point of view of materiality, was a reference to a winding down of Met Life's business in Poland, as a result of changes in the previously privatized national pension system.  The CEO of AMEA noted changes coming in 2014, as a result of the government having to make emergency contributions to the plan assets.  Opponents of the 1999 privatization charge that the costs of the investment products and fees were exorbitant, where some of it surely has to do with plan design, benefit changes, and with economic trends.

GDP growth in Poland has been less than 1.1%, and the public deficit as a percent of GDP is at 4% versus the EU required target of 3%, which could trigger mandated EU austerity.  The system will likely be renationalized, according to local observers.  Met Life assets under management total around $7 billion, and all deferred acquisition expenses related to Met Life assets have been written off.

This company has been a quiet, perhaps sleepy performer which is in the midst of trying to unify and globalize its brand.  As such, some of their investor include value-oriented mutual fund operators like Dodge and Cox and Mass Financial Services.  From much of the conversation on the call, this process has a solid foundation, but is just beginning.

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