美國信安金融集團 (PFG) 2003 Q4 法說會逐字稿

Good morning, and welcome to the Principal Financial Group fourth quarter 2003 conference call. There will be a question and answer period after the speakers have completed their remarks. If you would like to ask a question at that time, simply press star and the number 1 on your telephone key pad.

I would now like to turn the conference over to Tom Graph, senior vice president of investor relations.

Thank you, good morning and welcome to the Principal Financial Group fourth quarter conference call. If you don't don't already have a copy, our financial release can be found on our website at www.principal.com/investor.

Following the reading of the Safe Harbor provision, the CEO Barry Griswell and CFO, Michael Gersie will read some prepared remarks, then we will open it up for the questions. Others available for the Q&A are John Aschenbrenner, responsible for life and health insurance and mortgage banking segments, Jim McCaughan, responsible for global asset management, and Larry Zimperman, responsible for U.S. and international asset accumulation. Julia Lawler , senior vice president and chief investment officer will be available for questions.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the private securities litigation reform act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause actual results to differ materially are discussed in the company's annual report on form 10K for the year ended December 31, 2002 and the company's quarterly on form 10Q for the quarter ended September 30, 2003 filed by the company with the Securities and Exchange Commission.

Barry.

Thanks, Tom, and good morning. Let me also extend a very personal welcome to everyone on the call.

This morning, I will provide a brief overview of our results, focusing most of my comments on key accomplishments and progress in executing the strategy during the fourth quarter and for the year. Mike Gersie will follow my comments with a detailed overview of financial results.

2003, especially the fourth quarter, was extremely challenging, we are very pleased with our results for the year. In 2003, we delivered a 7% increase in earnings per share on 751 million in operating earnings, our 5th consecutive record year including record earnings in three of our four operating segments. Beyond strong earnings from our core retirement business, we achieved record results in pension, account values, deposits, and net cash flow, as well as record sales in each of our key retirement in pension products, pension full service, accumulation, mutual funds and individual annuities.

As you know, our primary challenges came from our mortgage banking operations, particularly the second half of the year with rising and volatile interest rates following an unprecedented refinance boom. As described in our fourth quarter earnings release we had two items impacting mortgage banking, the restatement of third quarter results and the write down of our mortgage servicing assets. Mike Gersie will discuss these further in his remarks, but I will make some comments here as well.

First the restatement, as you may recall, last quarter we discussed FIN46 and bringing the loan facility used to fund new mortgages on to our balance sheet. We early adopted FIN46 in the third quarter, working with the mortgage banking segments independent auditors to implement this complex new accounting standard.

At that time, we believed we had appropriately recorded appreciation on mortgage loans held for sale in the warehouse facility as earnings in the quarter. Upon further review last week, it was determined that we recognized the earnings one quarter too soon.

The restatement backs $31 million out of the third quarter operating earnings and puts $32 million in the fourth quarter, which is when the loans were sold. So, again, this is simply timing.

Moving to mortgage servicing rights assets, I would first like to emphasize that we are extremely diligent about validating our mortgage service and valuation model and capitalizing the asset within an appropriate range. We also have been very very transparent splitting out changes in MSR values resulting from model changes from all others. Every quarter for the last five-years, we have had at least one independent valuation of our MSR which we believe is a clear reflection of our on going commitment to place a fair value on the asset.

Because there were few active sales to define market value, we felt it appropriate to get a second appraisal. This gave us a broader range of values leading to our decision to take the writedown. In line with the range we announced in mid-December the fourth quarter writedown of $87 million after tax, clearly dampened fourth quarter and full-year results, and I don't want to marginalize the writedown, but I would point out it doesn't diminish the ability of the mortgage banking business to drive solid results going forward and it doesn't negate our tremendous accomplishments during the quarter and the year across our other businesses and it shouldn't over overshadow truly outstanding fourth quarter performance in U.S. asset management and accumulation where operating earnings increased 41% from a year ago to a record $118 million.

Today we are at the strongest point in our history. We are well positioned to execute our growth and to continue delivering superior long-term results for our shareholders. At year end 2003, our share price had appreciated 61%, in the 26 months since our IPO. By comparison, the S&P 500 index appreciated less than 2% over the same period.

As we enter 2003, we remain focused on several key areas to to build value for our shareholders. Accelerating growth in our U.S. defined contribution businesses, driving international growth and profitability, creating a successful asset management organization, operational excellence and effective use of capital.

Looking back at our results of these key areas, I would characterize 2003 as a strong year of execution. Our efforts to accelerate growth in our U.S. defined contribution businesses yielded outstanding results. Pension earnings improved 25% in the fourth quarter to a record $93 million, and 15% in 2003 to a record $346 million. Each of the pension businesses delivered double-digit earnings growth in the fourth quarter and for the full year, including full-service accumulations improvement of 29%, and 12% for the quarter and year respectively.

Powered by strong net cash flow and greatly-improved investment performance, pension full-service accumulation account values increased 30% or $13 billion compared to a year ago, compared to a year ago to a record $56 billion. With a turn around in equity markets, credited investment performance improved significantly during the year, contributing $8 billion to growth.

The remaining increase from a year ago reflects nearly $5 billion in positive net cash flows, a 69% improvement over 2002. The 2003 total equates to more than 11% of the beginning of year account value, nearly twice our long-term expectations of 6% per year for full-service accumulation.

This improvement in full service accumulation net cash flow is largely due to higher deposits, reflecting increased contributions from existing customers, and strong sales. It also reflects lower withdrawals, deposits increase by $1.4 billion, or 13% for the year, to $12.6 billion with contributions from existing customers making up nearly $8 billion or 61% of that total.

As many of you have requested, we are now providing a breakdown of full-service accumulation sales between organic and acquisition related. In total, full service accumulation sales came in at a record $6.4 billion in 2003, including $1.8 billion in the fourth quarter, which is our best organic sales quarter ever. For the gull year, organic sales made up $5.6 billion or 88% of our total, representing 22% growth in organic sales compared to 2002 and 70% improvement from two-years ago.

Importantly, since wrapping up our key core conversions in the first quarter, full service accumulation sales have trended strongly upward, including a 55% increase in fourth quarter sales, compared to the third quarter. Based on our continued momentum, we are establishing new organic sales targets for 2004, ranging from $1.2 to $1.8 billion per quarter.

I would add that alliance sales, a key component of sales growth, continue to be outstanding. In the fourth quarter, alliance partners delivered $571 million in full service accumulation sales. Alliance sales have improved 58%, up nearly $670 million to over 1.8 billion for the year.

In addition, new bank relationships in the bank channel and strong demand demand for our fixed annuities drove record individual annuity sales to $1.4 billion in 2003, an increase of 30%. For the full year, full service accumulation withdrawals improved by 7%, or approximately $600 million. Our employer level retention remains among the highest in the industry.

We also continue to make excellent progress in retaining plan participants. Our rollover asset retention rate remained outstanding coming in at 54% for the quarter and for the full year, making us an industry leader in retention.

Our ability to grow also reflects continuous refinement and improvement of our product and service platform. In 2003, we closed our acquisition of BCI group, adding to our defined benefit and ESOP capabilities, and enhancing our ability to deliver total retirement solutions. We also launched a number of new product and new product enhancements such as principal income IRA, which is focused on retirement income management and an array of new product education tools, helping participants plan for and achieve their retirement goals.

In terms of accelerating international growth and profitability, Principal International continued to make excellent progress with a solid fourth quarter and an outstanding year. In 2003, Principal Financial's earnings improved 58% to a record $35 million. [inaudible] increased 35%, reflecting organic growth, and a number of strategic acquisitions, including [inaudible], a mutual fund company in Mexico. Assets under management also increased strongly up 70% to $7.5 million at year end.

Moving to asset management, principally global investors continued to increase its presence in the global asset management . We won 76 new third party institutional investment mandates, an increase of 171% in 2003, which contributed to a $10 billion or 65% increase in on affiliated assets under management.

Spectre asset management, our preferred subsidiary, played a key role in this growth with assets under management increasing nearly $5 billion in 2003. During the year, Principal global investors also announced the acquisition of an interest in post advisory group strengthening our high yield fixed income expertise.

While we must continue to work on improving investment performance across classes, Principal Financial made additional headway in terms of equity investment performance. For the 12 month period, 69% of domestic and international equity funds in the pension separate accounts were in the top 2 Morningstar quartiles at year's end, compared to 55% a year ago, for the three-year period, our performance also improved with 58% in the top half at year end compared to 55% at year end 2002.

As previously highlighted, I will touch upon two other key areas of focus. Our operational excellence program continues to concentrate on process improvements, performance management, vendor, contract negotiations ask employee cost management. Those initiatives contributed well in excess of $25 million and targeted expense reductions for 2003. We will continue working hard to identify sustainable ways to improve the efficiency and effectiveness of the organization, and we are committed to exceeding our $25 million target again in 2004.

In terms of effective use of capital, during the year, we announced a number of strategic acquisitions, several of which I have already mentioned. In addition, to utilizing capital to fund organic growth, and for acquisitions, our top two priorities in 2003, we bought back 15 million shares for $453 million or an average price per share of $30.25, finishing the program authorized by the board in November of 2002, and, completing approximately 1/2 of the program authorized in May 2003.

We will continue to opportunistically repurchase shares going forward as an option for utilizing excess capital.

Before I move to guidance, I would like to mention some very important third party recognition. From CFO affirming our position as the 401(k) leader in the small and and medium size business segment, affirming our leadership in meeting customers retirement service needs, from information week, affirming our commitment to innovation and technology and from AARP, Latino style and the national association of female executives, as well as computer world and working mother magazines affirming our status as one of the best places to work. Most recently in January, we were again named to the fortune 100 places to work, of which we are extremely proud.

Moving to operating earnings guidance, we expect the first quarter, 2004, to range from 61 to 65 cents per diluted share, and full-year 2004 operating earnings to range from $2.70 to $2.80. 2004 estimates are based on certain assumption, including improvement of domestic equity market performance of roughly 2% per quarter from the December 31, 2003 levels throughout 2004.

In 2003, we accomplished a great deal. But there is still so much more for us to achieve. ROE, for the trailing 12 months, was 12.3%, below our 12.5% target for year end 2003.

In 2004, we will continue working hard to extend our leadership with small to medium-sized businesses and their employees, to be a great place to work and to create value for our shareholders. Through our efforts, we are effectively positioning the organization to take advantage of a fuller recovery in the economy, and we are confident that with a continued recovery and modest equity market growth, we will be able to achieve at least a 50 basis points improvement in our ROE by year end 2004, over our 2003 ROE target of 12.5%.

Mike.

Thanks, Barry.

This morning I will spend a few minutes providing additional highlights for the quarter and the year and financial detail for each of our operating segments. I will close with some brief comments on the quality of our general account portfolio.

As Barry indicated, we are very pleased with our overall results for the year. We delivered good earnings per share growth in 2003, particularly in light of the lingering effects of the weak economy and higher security benefit costs of $54 million after tax, or 16 cents a share compared to 2002.

There are several things I would like to highlight at the segment level, starting with U.S. asset management and accumulation. Segment assets under management are up $29 billion or 31% compared to a year ago driving company assets to management to a record $145 billion at year end. Compared to a year ago, segment earnings increased 41% in the fourth quarter to a record $118 million.

Pension was the main contributor to improved earnings, increasing 25% to a record $93 million. As Barry mentioned, each of our pension businesses delivered double-digit earnings growth in the fourth quarter, as well as for the year. For the full year, segment earnings improved 17% to a record $434 million.

In addition to pension strong contribution, our mutual fund and individual annuity businesses also delivered significant earnings growth in record performance. Mutual fund earnings more than doubled from a year ago and individual annuity earnings improved 44% to $39 million.

Within our international asset management accumulation segment, Principal International's fourth quarter earnings were $8.2 million compared to $9.7 million in the year-ago quarter. Year-to-date, Principal International's earnings are up 58% to a record $35 million. The year-to-date improvement reflects strong growth in our pension business in Mexico, aided by our two recent 4 A acquisitions and growth and acquisitions and asset management in Brazil. 2003 earnings did benefit foreign policy several one time small items. So in guiding for 2004, we would expect Principal International's earnings to range from $8 to $11 million per quarter.

Moving to life and health insurance, earnings for the quarter were $66 million, up $5 million compared to a year ago and and well above our normalized quarterly earnings for the segment. There were several items impacting comparability, which I will describe briefly.

In December, we implemented improved financial valuation models for deferred policy acquisition costs and policy reserves in some of our individual life and disability products. The conversion to the new models resulted in a one time writeup or deferred policy acquisition cost asset, and a reduction in amortization expense, increasing life earnings by $17 million after tax.

This impact was partially offset by a one time writeoff of accrued investment income in connection with distribution alliances in which the company has invested, as well as some negative but normal plain fluctuations in group health and group life, which in total reduced earnings by $8 million after tax. Excluding all of these items, segment earnings would have been very comparable to our normal run rate, which is previously guided is in the mid $50 million range per quarter.

In 2004, we will continue working to improve our competitiveness, focusing on our key growth markets and opportunities to generate sustainable profitable growth for the segment. We are already seeing some signs of improvement.

In the first quarter, covered members increased for group medical and group, dental vision compared to the third quarter. We are also experienced experienced improved lapse rates in the third quarter and for the full year in these businesses. This progress gives us confidence our initiatives will begin to drive growth in 2004.

I will now move to mortgage banking. Let me briefly elaborate on Barry's comments regarding FIN46, consolidation of variable interest equities in our third quarter statement. As you may recall prior to FIN46 adoption we had an off balance sheet facility used to finance mortgage loans prior to their sale.

FIN46 caused us to move the facility on balance sheet. We hedged the value of loans between the loan commitment and time of sale. Our hedging program has been economically effective, and and at the time of FIN46 adoption, we believe we had appropriately recorded earnings for the appreciation of loans held for sale in our warehousing facility.

In completing additional review of the application of FIN 46 and the year-end closing process, we determined we did not qualify for hedge accounting treatment under FAS133. Because we didn't qualify, we needed to back earnings out of the third quarter and into the fourth quarter, the period in which the loans were sold. It is important to note that the company had correctly recorded hedge losses in the third quarter.

As Barry described, the restatement primarily changes the timing of financial statement recognition. The change had no effect on the economic results of hedging activities or cash flows for any period. Going forward, we expect to meet the rigorous documentation standards required by FAS133, even though the actual hedging strategies themselves, which have been effective in economic terms, will not change.

I will now spend a couple of minutes discussing the components of fourth quarter earnings, as well as how we expect earnings to emerge for the mortgage banking segment in future quarters. The segment had a $43 million loss in the fourth quarter, and $53 million of earnings for 2003. In line with the range announced in mid-December, we took a fourth quarter write down for mortgage servicing rights asset which reduced fourth quarter earnings by $87 million after tax.

As described in December, and as Barry mentioned in his remarks, a writedown reflects on going efforts to fairly value the mortgage servicing rights asset. As you know the mortgage servicing rights asset must be held at market value, but with continued interest rate volatility, in the absence of an active servicing market, it becomes very difficult to determine market value.

Because of this, we added a second independent appraisal in the fourth quarter to get additional evidence to support the company's valuation. Based on the two appraisals, which showed somewhat differing views of the MSR market, we performed additional analysis of our portfolio.

We then made enhancements to our model, which put our mortgage servicing rights near the midpoint of the range of values indicated by the two appraisals. As Barry mentioned, the writedown doesn't diminish the ability of mortgage banking business to drive solid results going forward. While no one can predict exactly where interest rates and mortgage mortgage rates will go in the future, we are confident that the write down puts this valuation is behind us.

Breaking down the $43 million fourth quarter loss for the segment, reduction generated $53 million in earnings, including $32 million from FIN46 adjustments. Servicing generated a $96 million loss. Production earnings were down from the $120 million in the fourth quarter of 2002, reflecting lower mortgage origination volumes and tighter margins.

The $96 million loss from servicing reflects three items, the $87 million MSR writedown, $27 million writedown from servicing operations and a $36 million loss netting the writeup of the MSR asset due to rising interest rates against losses on financial hedges. The earnings from servicing operations, included a $12 million gain on the sale of high coupon delinquent Ginnie Mae loans and servicing.

Losses and hedges exceeded the writeup in MSR values for the quarter for two reasons. Loans paid in full were greater than amortization due to an industry refinancing backlog at the beginning of the quarter and a less than parallel movement in mortgage interest rates relative to the movement in financial hedges.

In the future, we expect more normal hedge results. Based on our FAS133 definitions our hedging remains satisfactory so we are not at risk of losing hedge accounting treatment on the MSR asset. As we continue to transition from production to servicing we expect to see minimal losses from assumption changes, more hedge results and improved earnings from servicing operations as amortization expense moderates further.

I will briefly share a couple of additional points on our mortgage banking business. At quarter end, the weighted average interest rate of our portfolio was 5.95%. Nearly $93 billion, or $119 billion servicing portfolio, or 78%, now has an interest rate at or below 6.5%.

We have continued to build a large valuable asset that will continue to grow in value as as interest rates rise. As such, we reiterate our earnings expectations for 2004. $25 to $30 million of operating earnings per quarter for the segment.

I would now like to briefly discuss credit quality and our fixed maturity securities portfolio. After tax net realized capital gains of $16 million for the quarter, reflect $28 million in losses from impairments and impaired sales of our fixed maturities.

For the year, net realized credit losses declined 58% from $297 million in 2002 to $124 million. The strong improvement reflects better credit quality overall, our continued aggressive monitoring of each investment, and active management of problem and potential problem investments.

At $152 million gross and realized losses have improved significantly as well, down 69% compared to year end 2002. Gross and realized losses equate to only 4/10 of 1% of our fixed maturity portfolio. Further only $4 million, or 1/100 of 1% of our fixed maturity portfolio has declined and remained below amortized cost by 20% or more for six months or more for longer.

At year end our watch list has declined significantly from 2.6% of our fixed maturity portfolio a year ago to 1.2%, improving by $452 million over the period. Given these improvements, we expected credit related capital losses of $25 million after tax in the first quarter of 2004, and $65 million after tax for full year 2004.

This concludes our prepared remarks, and I would now ask the conference call operator to open the call to questions.

At this time, I would like to remind everyone to ask a question, please press star and the number 1 on your telephone key pad. We will pause for just a moment to compile the Q&A roster. The first question comes from Jason Zucker, Fox, Pitt, Keltin.

Good morning, thank you.

Thanks for giving out all the organic growth number, something I had been hoping to see for a while. But what I want to go back to is what I perceive as a little bit of a mixed message. I was writing down numbers fast, so maybe you can clear this up for me. Here is what I have got. Guidance for full-service pension in '03 was 1 billion to 1.5 billion a quarter, now that up 20% from 1.2 to 1.8 billion, we did 5.6 billion in full pension service sales in '03, but that suggests a range for 2004, or growth rate of 2004 of minus 14% to 28%. That would be the 1.2 billion at the low end and the 1.8 billion at the high end each quarter quarter, or a midpoint of only about 7% growth. Is that correct?

Yes, thanks, Jason. I think what we are trying to do here is to not be so precise on a quarterly basis. Unfortunately, there are certain quarters that have a very significant amount of seasonality to them. So in those quarters, you would see it, certainly up to the 1.8, maybe even above, and then there are other quarters, because of the way renewals happen and cases come in, it would be, you know, far less. I think we have said that we would expect somewhere probably in the 15 to 25%.

Right.

Organic growth, and that continues to be true. It is just the way we are giving the quarterly guidance to not have people get concerned if there was a quarter when it was 1.2 or so because of the seasonality in the business.

Okay, good. And then just a numbers question which I think I missed. Can you tell us what the fourth quarter full service pension organic growth was?

The full-service accumulation was 1.8 billion. For the quarter.

Yes. What is that growth rate versus last year?

Last year, organic was 9, was 1.3 billion.

Great, okay, thank you.

The next question comes from Nigel Dally of Morgan Stanley.

Great, thanks, two questions, first to your mortgage operations, obviously an area of disappointment this quarter. Given the challenges can you discuss your long-term goals and whether you consider getting out of the business, and second, whether you could discuss how much prepayment income influenced results for this quarter. Thanks a lot.

I will take the first first one and have Mike take the second.

You know, we -- I believe very strongly that this is the best time for us in the mortgage banking business. We believe we have the MSR issue put behind us. We have a great organization. You know, I would just point out to people, you know, just about three-years ago, we were making, when we had about 50 billion of loan servicing, we were making about $50 million. If you take the two-years together that we have just completed, we made about $100 million for year on average for the last two-years, and that we now have $119 billion of loans that we serviced. So I think going forward, you should see as we have said to people in the $25 to $30 million quarter per range is the normalized kinds of earnings and I believe we are in one of the best positions we have been in. We understand this business, we have the MSR fairly valued, and so I don't think there is a need for a knee-jerk reaction to get out of this business.

We are committed to shareholder value, we will continue to look at what is what is right by our shareholders, we will continue to analyze this business as well and make the decision based on how we can generate the best long-term shareholder value for our shareholders. Mike, prepayments?

Yes, prepayment, is roughly about $15 million in the fourth quarter. That was up from about $5 million in the fourth quarter of 2002. Much higher than expected. I mean, obviously prepayments come in in lumps and be got a big lump in the fourth quarter.

That was a pretax or after tax number?

Pardon me.

Was that was pre or after tax?

That was pretax number, I believe.

Okay, great. Thank you.

The next question comes from Liz Warner, Sandler O'Neill.

Good morning. Actually, we are only allowed to ask one question, right? Or one followup, Liz. Okay, I'm sorry. My first one is just, with regard to the mortgage business, as we think about the 25 to 30 million per quarter, what would be the one thing that would be most likely to cause any quarterly volatility to that number? Would it be interest rates, and is it possible to say, you know, X basis point change in interest rates creates X dollar amount of potential volatility. I am thinking that it would become, hopefully, a little bit more of an annuity stream going forward?

Sure, I will let John answer. I will give you my quick overview comment, what we really need is stable and slightly increasing interest rates. That's the easiest way to get from a production environment to a servicing environment, and we have had, unfortunately, very volatile interest rates. They appear to be going up and then you have spots during the month or quarter when they actually go back down. So that is really what is causing the problem, but, John, you maybe want to add a little bit to that?

Yes, there is not really much to add. I think the key, I think the piece that is going to add the most volatility is the movement in interest rates causing the MSR value to go up and down, with the hedging results on that MSR value, and there isn't a good formulaic approach to say, if it goes up a quarter, here is exactly what is going to happen, or down quarter. That is really where the volatility will come from.

Okay. My followup is what is your excess capital at this point. You already gave us your prioritize for use, so if you could tell us how you view excess capital, that would be great.

Level of excess capital at year end was around $250 million.

Thank you very much.

Let me do a followup to Nigel's question. That was really an after tax number. That 15 million of prepays was after tax.

Let me do a followup to Mike's answer on the excess capital. You know, we do, we don't have the final answers from all the rating agencies. We still feel like we are working through all of that. We feel like we will be in very good shape and we believe that going forward we will be able to generate a fair amount of excess capital from our earnings that we believe can be divided to the holding company on an on going basis, so we do think the prospect for generating excess capital is quite good in the organization.

Thank you. The next the question comes from Eric Berg, Lehman Brothers.

Thanks, and good morning. Mike, Mike Gersie, can you go over, can you go over and elaborate on the two reasons that you cited for why the hedge was not as effective as you would have liked in the December quarter in the mortgage area? And, relatedly, this is my one followup. In as much as there have been just as many periods as I look in your financial supplement, when the hedge really performed poorly, as there were periods in which it performed well, why should we have confidence that you are going to qualify for hedge accounting?

I mean you thought you would in the September quarter. The auditors came in and he told you to restate your financials. Given your hedge history, which has been, well, kind of uneven. Why should we have confidence that you will qualify for hedge accounting respectively? So two related questions. Thank you.

Let me answer the second question first, and then I think John Aschenbrenner and I will split the first question.

The second question regarding qualifying for hedge accounting, that was really related to hedging a different asset, and it really related more to getting the documentation in place to qualify for FAS133 accounting. In order to qualify for FAS133 accounting, you need to first affirmatively say you are going to apply for it, and then you have to specifically state the methods you are going to use to measure the hedge, and we didn't have that done on that particular asset in the third quarter.

And keep in mind, we didn't have to have it when it was off balance sheet, when it was in a facility.

Right.

It wasn't a requirement.

So it was a little bit more of a -- I will say more of a technical issue with that particular hedge. Now, getting back to the service-related hedge in the fourth quarter, I think if you focus on the aspect of the second component of the basis change, really, what happened was the hedges protect you from parallel movements in interest rates of two assets.

You really can't -- it is very difficult to protect yourself if two assets are moving in different directions, and that's one of the things that hung us up in the fourth quarter, the fact that the hedge asset was moving in one direction, and the mortgage asset was moving different and in a nonparallel direction in the fourth quarter. Thank you.

Yes. I would adjust a little bit. As far as testing for hedge accounting for the servicing, that's something that we have to do in great detail. We don't hedge all of the traunches, so there are lots of traunches, some hedged, some not hedged. We have to look at it in shorter periods of time, not just over the quarter.

But for our hedge test, in the fourth quarter, for FAS133 on the servicing asset, we were -- had a 92% correlation through the technical definition. So we are in very good shape technically on FAS133 hedging.

The other thing, you know, I think Mike explained this pretty well, but in the fourth quarter, one of the reasons the hedges did not work as well as we would have liked is Mike talked about the changes in the curve shape, mortgage spreads versus LIBOR, and the volital assumption, so there are a lot of pieces that caused the mortgages to move a little bit differently than the hedges.

The other thing that happened is that because of the huge backlog in refinances, in the fourth quarter, we had a backlog of finances, refinancing from earlier quarters that came through, or actually paid in full, that came through the fourth quarter, that exceeded amortization. So the value did not go up as much as it would have without that happening.

Thank you. The next question is from Colin Devine, Smith Barney.

Good morning. Barry, you provided updated sales targets for your 401(k) business. Perhaps, I was wondering if you might share with us what you are looking for in net flows since I think that is really the underlying in your growth and then secondly, Mike's comment about the excess capital position, I was a little surprised it is down to just 250 million, and I am wondering if that's because you are under some pressure from the rating agencies to hold more capital to support the mortgage business because of its volatility, and, if so, what sort of ROE should we be looking for from the mortgage business going forward, and how does, perhaps, the change from the rating agencies impact how you are looking at where that business fits? Sure, Colin. Let me ask Larry to answer you first and then Michael talk about excess capital again.

Good morning, Colin, this is Larry.

On the question about net cash flows. As we have said to you, we think that the best model going forward would be to assume that we are going to grow our premium and deposits in the range of 15% for the year, which, again, we have been doing over the most recent history, and given our success at asset retention which, we are going to sort of continue to try to work more incrementally work at it and we see more opportunities there. I would expect that you would see us be able to grow our net cash flow somewhere between that sort of 15% to 18% on a go forward basis.

I will let Mike answer the other question.

Yes, Colin, you spoke about 250, last quarter we spoke about having roughly half a billion dollars of capital, the reason for the decline was the dividend to stock holders, that was about 150 million, and then spending a little bit of capital on some of our modest acquisitions that we made during the quarter, so that brought us down to 250.

As Barry mentioned earlier, we believe that we are reaching a conclusion with the rating agencies, and so we think we are getting to the, I will say the right capital level that will satisfy Moody's and Standard and Poors. That has resulted in a little bit of an increase in the capital allocated to the mortgage banking business but not an appreciable increase. We would still expect that business to earn somewhere in, I will say, 15 to 18% on an on going basis. As Barry mentioned also, having gotten our capital pretty well calibrated, we would expect to generate excess capital going into 2004 and beyond.

Okay. Thank you.

Thanks, Colin.

Thank you. The next question comes from Tom Gallagher, CSFB.

Good morning. Two quick questions.

The first is, can you just comment on the pipeline for your 401(k) basis as it relates to 1Q.

Does the strong momentum from this quarter, is it carrying over, and should we expect to see fairly strong sales and net flows? And then just a followup on when can we expect to start seeing better growth out of your life and health business, and do you have any initiatives in place to improve revenue and sales momentum there?

Sure, we would be glad to answer those. Let me ask Larry and John to split those up. Larry.

Good morning, Tom. I will I will comment on the Q1 pipeline.

We are still seeing all the positive trends around our sales growth and our sales momentum. As Barry said in his comments, we are particularly focused on continuing to see growth of our alliance sales activity, and as Barry commented on in his remarks, we are also very, very excited and very hopeful about moving to more of a total retirement solution platform in 2004. We think there is a lot of opportunity in sort of the mid-market and sort of the lower end of the larger market for our total retirement solutions, which really brings to the table our defined benefit, our ESOP, our defined contribution and our nondefined capabilities all in a single platform. So we really think that will give us great opportunities going forward and we would expect again to see that sort of 15 to 20% growth in accumulated sales that Tom talked about.

I will let John comment about life and health.

Yes, I am going to break it into three pieces, I think. I will start with the medical and dental, and there, you may have noticed that we did show growth in dental, both at the last two quarters. We showed some slight growth in medical the fourth quarter. We believe that is just a start toward seeing some much better growth going forward in 2004.

A lot of that is resulting because we are much more focused on a smaller geographic region. We are making product changes that make us more flexible and cost-effective in those regions, and we are starting to see some better success in the network relationships and discounts within our focused regions.

On disability side, we are getting some pretty good growth in disability. We expect that we will continue and even pick up in 2004, as the wholesalers that we added a couple of years ago are maturing and we are continuing to add wholesaler on the group nonmed side.

On the life insurance side is where we need the most improvement. On group life, we had the same things going on, as I mentioned with disability, with the wholesalers getting more mature and effective. Significant growth in wholesalers this year, and much more of an emphasis on package sales of tying the life insurance into some of our other products, that should help us with the group life.

On the individual life, it's a combination of we had moved to a different wholesaling model on the independent side, and we are adding wholesalers there. We have added six new career units with significant number of new agents coming with those units, and we have got some very strong product development and solution packages that that have either just come out or will be coming out in the very near future. So you should on the individual life side start to see some good increase in the sales and revenue side in 2004, just growing as the year proceeds.

Okay, thanks, and just one quick followup.

Can you just comment on signa related transfer activities and kind of the experience level that you experienced during the quarter?

Sure, Tom, this is Larry. I will comment on that quickly. We have, we have seen a relatively modest amount of that business so far, maybe somewhere in the ballpark of approximately $100 million in sales. As you know, that's a fairly complicated transaction, and those existing clients will go through quite a long period of time as they assess what their options are. But we are starting to see that pipeline build, and I think that will continue on into 2004.

Okay, thanks.

Thank you. The next question comes from Jeff Hobson, AG Edwards.

Hi. Can you give us any update on the environment in the pension market in terms of buyer receptivity, consolidation?

And then you mentioned the total of retirement solutions being on the same platform now. Can you tell us exactly what that means and how, how that will impact sales going forward?

Sure, Jeff. Let me just comment on the first and Larry can add to it and answer on the second.

We continue to believe that consolidation will occur in the defined contribution area. I guess the lift in equity markets may cause some folks to think they are doing better in that business than they really are. But we don't think it is a matter of if it will happen but when. So we expect the trend to continue.

We are going to move toward a policy. I would just point this out to you, that we are most likely to do deals. If we are going to do a deal, you will hear about it much later after the fact than before the fact. It is obviously not to anybody's benefit to public announcement of something in the works and then have all the competitors in there. So to the extent that we do have anything in the future, my guess is you are going to hear about it after it is pretty well done. But we do believe some deals can be done, even though as I said the equity markets are probably going to cause some people to not be as receptive as otherwise.

Larry, total retirement service?

Yes, Jeff, on your total retirement solutions, as I said earlier, that is basically bringing together a number of product solution, that, again, I think puts principal in a very unique position relative to our competition.

There are a lot of 401(k) competitors out of there but when you start talking about 401(k) nonqualified defined benefit and ESOP which many of the smaller and mid-sized markets have, all of those product solution needs, our ability to kind of bring those together on a single platform, a single data reporting source, a single website, a single participant statement, I think what it does effectively Jeff, is it sort of takes the competition from, perhaps, something measured in hundreds in terms of 401(k) competitors to something measured in terms of 8, or 10 or 12. So, again, we are very excited about that. We have been working really hard on fine tuning our value proposition on total retirement solutions and again we think it has a lot of opportunity for us going forward.

Thank you.

Thank you. Your next question comes from Mario Madonca from CIBC world markets.

Good morning, everyone.

Your positive outlook for full-service accumulation sales, is that premised or do you presuppose anything from a legislative front, specifically as it relates to the lifetime savings accounts?

Well, I think what is baked into that is no changes on the legislative front. On the legislative front, we have actually had some very positives the last couple of years, there is actually a bill pending now that would that would also be very positive on the president's recommendation, LSAs, RSAs and and ERISA, the latter two ERISAs and RSAs would probably give us a boost, they would probably be positive.

The one that I think would be detrimental to us and many other service companies are LSAs that would basically give the people the ability to save short-term with no consequences of getting out, no restrictions, and we think that would be very, very bad public policy. I don't think it is going anywhere, quite frankly, in 2004. It may reappear. We are going to be vigilant in making sure that we point out the inappropriateness, I think, of that kind of a savings vehicle. It would detract, we believe, from long-term savings and would be detrimental to the country.

Clearly, you prefer a democratic government, I suppose?

Clearly, we would prefer not to have LSAs.

Right. The followup question, then, is back to the excess capital. The $250 million in excess capital, I think of that more in the context of of all the statutory earnings the company generated in the year. Stat earnings in the year I imagine were normally healthy. They are pretty much are in relation to your GAAP earnings. Where would all of that excess capital go. Would that be reinvested in new business?

Yes. I think the big chunk of that would be reinvested in supporting the growth of our existing businesses. Another piece of it, quite honestly, is in retaining additional capital in the life company, to meet the rating, the expectations of rating agencies in terms of capital in the life company. So, in 2003, we really didn't dividend any amounts from the life company to the holding company. We would expect in 2004 to be able to start dividending excess earnings out of the life company and into the holding company.

Keep in mind we did a 454, I think we said, million share repurchase. We did the dividend.

Right. So we used up some of the capital that we had at the holding company.

Sure. Thank you very much.

Thank you. The next question comes from Joan Zief Goldman Sachs.

Thank you, good morning.

Here are my two questions.The first is, you are talking about a 50 basis point movement and the return on equity up to 13% by the end of 2004. I thought you said? So, could you just give me the key components that are going to drive that rise in ROE.

And then the second thing I wanted to and you -- to ask you about, is the MSR asset is about 30% of your GAAP capital. Is it appropriate to look at your balance sheet in that way and, you know, how do you, how do you feel comfortable with that asset being as large as it is, relative to your total balance sheet capital?

Thanks, Joan. Mike, do you want to jump in?

Well, first question, Joan, how we are going to get to that rate of return on equity increase. Basically, through growth in operating earnings, coupled with, baked into, at least, the projections that we do, completion of the stock repurchase program, sometime during 2004, that the board has authorized. So that would include embedded in there, about $150 million of share repurchase, again on an opportunistic basis. Basically true, good old-fashioned work on our part to get to the higher number.

Does it imply a mixed shift in your earnings?

I think the mixed shift in the earnings is really, if you look at the growth in the accumulation businesses, both domestically and internationally. So, think of the lift being in the businesses, at least you think about, a business which has a 17 to 18% return on equity, think of most of the growth being in that operating segment.

Second question?

And the second question, second question was? 30% -- well, the MSR asset being a large proportion of capital. The way I would answer that, Joan, is as long as we have that asset value right, and we do believe we have it valued appropriately, that that really is a very good and very solid asset. I think you could to some extent argue that it has a bit of -- I will say intangible nature about it, because it really is the right to receive something. But the way we look ate, and the way it is modeled, and the way it is valued, we really do believe that is a really very good, very solid asset for us, and the value we are carrying it at, if we chose to put it on the market, with a willing buyer, and willing seller, that is the test of market value that we could receive the value we are carrying for that asset.

And the rating agencies don't have any sort of cap that they look at, as to what an appropriate percentage should be, as long as it is valued correctly?

No, they don't, Joan.

I think what they would look at, more than the value of the asset, would be, one of the things they would look at is how large, not so much the asset, but how much income is being recounting on being generated from that part of the organization, and so they would say, if you are in the 15 to 20% range, that's about the right size of that operation for the principal, and that's about where we are.

Joan, this is John Aschenbrenner. I would add another comment.

We have operated the mortgage banking basis on kind of an opportunistic basis, and the last few years have been a tremendous opportunity to grow the business, and so it has grown to a larger portion of the principal than it was in the past. We would not expect that to continue.

So, as we go forward, we would expect that the growth in the mortgage banking business would slow down dramatically because of the change in the mortgage market, and we would expect the rest of the company to outpace the growth in the mortgage banking business substantially going forward.

Okay. Thank you.

Thank you. The next question comes from The next question comes from Suneet Kamath from Sanford and Bernstein.

Great, thanks for getting me in here. Two quick questions.

First, I think you said on the MSR that you are using two third-party appraisals and that you kind of take the advantage, and you are kind of near that midpoint. Is there any way that you can tell us kind of how wide the range was, you know, 50 million, 100 million, that kind of thing. That's my first question.

The second question is, have you guys scheduled sort of year-end meetings with the rating agencies yet and in particular particular S&P?

Thanks, Suneet. I will ask John to answer the first question about the two different appraisals.

In terms of the rating agencies, those don't actually occur at year end. They actually occurred throughout the year, and we are in contact with them, of course, at year end, and everything is fine. We have our actual review meetings with them spread out throughout the year, I think starting as early as the spring and going throughout the summer. But, basically, you know, we basically have already had our meetings with them and I think the ratings, usually, and everything is very stable with the rating agencies at this point.

Yes. The range is pretty wide right now, because there is no market out there. And, and just in terms of basis points, it is -- the ranges tend to be probably in the 20 to 25 basis point range. So, 10 to 12, above the midpoint, 10 to 12 below the midpoint.

And we are at the average of the midpoint of the two.

Of the two, yes.

And just to follow up, you are talking about basis points as a percentage of the servicing portfolio, is that correct?

Yes.

Great, thanks so much.

Thank you. The next the question comes from Beth Malone.

Thank you, good morning.

Yes.

Could you just give us a little more clarity on you raised your guidance for 2004, and I am just wondering, what what type of environment do you anticipate that we have to see, and is most of that incremental upside, especially when it comes from the pension division?

Yes, I think that's right, Beth. I think the increase in guidance comes largely because of the nice lift we have had in the equity markets coming in in the first of the year. Any time you get that lift on January 1 or before, you have got, you can anticipate a full year of increased revenue and fees because of that.

We are still only projecting a 2% increase per quarter, but we are we are doing that on top of a fairly nice runup. That is largely what is going on with the increased guidance.

And what environment do we need? Well, we need 2% per quarter of equity growth. It would be nice to have fairly stable interest rates and continued growth on the economy.

One followup question, on the business you are getting from the pension market. Has that changed at all or are there different markets you are you are try to go approach, different size, pension customers, or is it basically the same business you have always focused on? ?

Sure, we will let Larry jump in and answer that.

Hi, Beth, this is Larry.

Basically I would tell you we are continuing down a similar path to what we have been down the couple of quarters, same trends continue, about 30, 35% of the business is brand new plans, startup plans, about 65% to 70% of it involves transfer money, the size of those plans stay consistent quarter to quarter and over the course of the year. Our value proposition plays very strongly in the small, in the mid, and again as total retirement solutions comes on it plays very well at the upper end as well. So we will be in every one of those markets.

Okay, thanks.

We have --

Let me -- Go ahead.

We have reached the end of our Q&A, Mr. Griswell, your closing comments please.

Thank you very much, I didn't mean to jump in there. Let me answer one questions that didn't get asked, but I think it is an important one, and I certainly wanted Tom to have the opportunity to talk to each one of you about it.

I think the question in our mind is how credible is the 25 million per quarter in the banking segment each quarter particularly when you you try to strip out the noise of the fourth quarter. One of the things that went on there, just to make you aware of, when we didn't qualify for the hedge accounting because of the FIN46, it did shift earnings from third quarter to fourth quarter and we made that adjustment.

But it also shifted some earnings that would have ordinarily been recognized in the fourth quarter into the first quarter. So we anticipate there is probably $10 to $12 million of additional earnings that have probably already in or are in the process of being earned because of the sale of those loans, and we believe that if you were really doing a complete analysis and trying to get back on an apples to apples comparison, you would put that earning back in the fourth quarter and you would have had a $25 million quarter, although be it it 15 million of that coming from the sale of some loans. We think that's a legitimate source of earnings, we do it quite often. Just to give you the clarity. Tom can follow up with you. I wanted to make sure you had that additional information to help you look at the fourth quarter earnings.

Well, let me thank you all again for your interest in the Principal. I know this has been a very, very challenging time for for you all. it has for us as well. We ended up in a very good spot, I believe, our prospects going forward are positive and we look forward to delivering on the commitments we have made to you today and throughout the year in 2004. So thank you all again for your support.

Thank you for participating in today's conference call. This call will be available for replay beginning at at approximately 1 P.M. Eastern time until end of day February 10, 2004. 4808487 is the access code for the replay. The number to dial for the replay is 800-642-1687 or 706-645-9291 for international callers.