FBR Capital Markets believes Prudential Financial Inc. (NYSE: PRU) will execute the $1.5- billion stock repurchase and will maintain an additional capital margin of $3.2 billion through the year-end 2013.
After hosting meetings with management and institutional investors, we continue to view Prudential as our top life insurance pick as it is the best risk-adjusted capital return story in the group, said Randy Binner, an analyst at FBR Capital Markets.
He said the challenge to the excess capital bull case for Prudential, or any life insurer, is that macroeconomic pressure (lower interest rate, equity market, and credit expectations) could be a call against the buffer.
Prudential clearly has lower interest rate exposure as half its business is in Japan (already deflated asset-liability match) and is more than one-third U.S. asset manager, he said.
As low rates are by far the main issue investors have with the space, lower exposure on this key issue is important given that shares have traded down in line with peers over the past month.
Prudential's management supported this view and was confident that low rates should not generate material reserve issues. He estimates that the statutory reserve test performed last year approximated a 10-year Treasury yield of 240 basis points and resulted in a marginal $140 million statutory charge.
If the 10-year ends 2011 at the current level, he would expect a further charge, although a similarly small figure. On the variable annuity (VA) side, DAC and VACRM should not have major impacts from low rates this year.
He said the buyback plan appears on track given management's high level of confidence that Prudential is less affected by current macro issues. Prudential still has significant excess capital capacity to pursue additional deployment. If the macro environment stays challenged, merger and acquisition could move back to the front burner as management has a track record of purchasing entities in times of distress.
Given Prudential's emphasis on captive distribution in Japan, the new DAC rule could affect the company more than its peers. While this change could lower GAAP book value by 6.5 percent by his estimate, this is not tangible book or statutory capital and is a known industry-wide issue.
Since Prudential changed its VA guarantee product, many investors have wondered if it was trying to significantly curtail its VA business. He does not think so, and Prudential should remain a top three writer, but now with a more conservatively priced product. Management does not seem close to a VA price change as the forward swap curve predicts higher yields.
In 2011 second quarter, Star-Edison reported $0.36 per share net of financing costs, above initial expectations. Prudential has not had any surprises with Star-Edison, which makes sense given two years of due diligence and that this is the fourth major deal of this type the company has integrated.
The brokerage maintained outperform rating on shares of Prudential Financial, while lowered its price target to $66 from $73.
Prudential stock closed Monday's regular trading down 3.67 percent at $49.56 on the NYSE, while in the after-hours the stock further lost 2.12 percent.