Credit analyst sees little reason to buy Prudential as insurer faces challenges

By Ronda Fears

Nashville, Tenn., Feb. 14 - Prudential Financial (A3/A-) reported a fourth quarter net loss of $506 million this week, in what looks like an inauspicious start to its life after the IPO in December. Gimme Credit senior bond analyst Kathy Shanley said Prudential faces many challenges in the current operating environment for insurance companies, and would not buy the credit.

"Like other recently-demutualized insurers, Prudential's challenge is to build on its historic strengths while cutting expenses and dealing with the pressures of being a public company," Shanley said in a report Thursday.

"We think it may be challenging for Prudential to jumpstart its growth quickly. We wouldn't be an aggressive buyer of this credit."

Prudential's net loss includes a $340 million demutualization charge related to payments for its Canadian policyholders, Shanoley said, but even without the charge she said the earnings were hurt by investment losses and weak capital markets. The bright spot, she said, was international where operating earnings more than doubled following an acquisition in Japan last year.

Also like several other insurers, Prudential's results took a hit from exposure to Enron, Shanley noted. Realized investment losses totaled $132 million, with gains elsewhere in the portfolio partially offsetting $196 million in losses on the disposal of what Prudential calls substantially all its Enron exposure. Total credit-related losses, including Enron, were $266 million within Prudential's financial services businesses. As the second largest life insurer, Prudential has a large exposure to fixed income securities, the analyst noted. Prudential's portfolio of fixed income securities includes about $78 billion in public debt (6% sub-investment grade) and about $32 billion in private debt securities (17% junk-rated).

Higher revenues for the quarter of $5.2 billion, up from $4.5 billion a year ago, reflects the international division's twofold gain to $1.4 billion, Shanley said. The international division was helped by Prudential's 2001acquisition of Kyoei Life Insurance Co., a troubled Japanese life insurer now renamed Gibraltar Life, for $1.2 billion. Pretax operating earnings at the international operations jumped to $125 million, up from $60 million last year. The company says it will consider additional acquisitions overseas. Although expanding overseas is one avenue for Prudential to increase its growth rate, it also entails above-average risks, as various firms like MetLife are now finding out as they take write-offs in Argentina .

Aside from international, Prudential's results were affected this quarter by the slowdown in the U.S. capital markets, with commissions, investment management fees and other income dropping about 9% versus last year to $1.1 billion. Volume is down in the brokerage business, sales of defined contribution products were down versus last year and managed assets also dipped on a year-over-year basis.

"Considering the state of the markets, this isn't particularly surprising, but it increases the pressure on Prudential to find ways to increase shareholder value," Shanley said.

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