Prudential Looks Strong: Analysts

Prudential sign (Photo: Douglas C. Pizac/AP)

The virus that causes Covid-19 pneumonia has been spreading, interest rates have been falling, and stock prices have been flying up and down like a broken drone.

Moody's Investors Service warned Wednesday that, if the new low, low interest rates persist, that could hurt U.S. life insurers' creditworthiness.

But a team of Morgan Stanley securities analysts who took a close look at one big life insurer — Prudential Financial Inc. — say the company appears to be prepared for what lies ahead.

The analysts have based that conclusion on talks with Prudential managers during a "virtual roadshow meeting."

Normally, executives from Prudential and other companies that sell stock to the public go on the road during the roadshows, to talk to securities analysts face-to-face. This year, because of the Covid-19 pandemic, companies and analysts are meeting through teleconferencing systems.

Here are three things the Morgan Stanley analysts say about Prudential, drawn from the analysts' roadshow meeting commentary.

1. Access to Cash

At the Prudential virtual roadshow meeting, given all of the investment market volatility, "one of the key questions revolved around liquidity," the Morgan Stanley analysts write in a commentary on the meeting.

The top-level holding company ended 2019 with more than $4 billion in cash, and another $4 billion in credit lines, or corporate credit card equivalents, with 20 banks, the analysts write.

Prudential has not had to use any of the credit lines, the analysts write.

Prudential also has access to another $5.5 billion in cash from an alternative trust funding source and from the federal Home Loan Bank system, the analysts say.

2. Operating Position

For Prudential, it looks now as if high Covid-19 mortality levels could do more to cut obligations at the company's pension risk transfer operation than to increase life insurance claims, the analysts say.

The analysts also say that the effects of "falling interest rates" on life insurers may be somewhat exaggerated, because different types of borrowers pay different types of interest rates.

Rates on the federal government's own Treasury notes and bonds have fallen close to zero, but life insurers invest mainly in highly rated corporate bonds, not Treasury notes and bonds.

The spreads between the rates paid by the Treasury and the rates paid by ordinary companies "have widened considerably," the Morgan Stanley analysts write.

At this point, the increase in corporate-Treasury spreads has compensated for the most of the effect of falling Treasury rates, the analysts write.

3. Muscle

Prudential told analysts it has little exposure to bonds issued by the kinds of companies suffering the most from the effects of Covid-19-related travel and business disruption.

Low rates might hurt sales of products like individual life insurance and fixed annuities in the short run, but, in the long run, the volatility helps illustrate the value of the products Prudential sells, the analysts write

Prudential managers also emphasized that the company is much stronger than it was before the 2007-2009 Great Recession, in part because the company now engages in extensive stress testing, and because it has had many years of experience with coping with low interest rates in Japan.

Prudential should have enough free cash flow in 2020 to keep paying stock dividends to shareholders in "all but the most severe scenarios," the analysts write.

The company board has allocated $2 billion for share buybacks in 2020, and the company is likely to be more flexible about share buybacks than about dividends, the analysts write.

"Whether they use this or not depends on other needs, which could be preserving capital if economic conditions deteriorate further, or funding an acquisition, similar to what they did in the aftermath of the financial services crisis," the analysts write.

— Read U.S. Life Insurers, Stocks Shook Off the 1918 Flu, on ThinkAdvisor.

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