保德信金融集團 (PRU) 2008 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Prudential first-quarter 2008 results conference call. At this time all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Senior Vice President of Investor Relations, Mr. Eric Durant. Please go ahead, sir.

Thank you, Rich. Good morning and thank you for joining our call. In order to help you to understand Prudential Financial we will make some forward-looking statements in the following presentation. It is possible that actual results may differ materially from the predictions we make today. Additional information regarding factors that could cause such a difference appears in the section titled Forward-Looking Statements and Non-GAAP Measures of our earnings press release for the first quarter of 2008 which can be found on our website at www.investor.Prudential.com.

In addition, in managing our businesses we use a non-GAAP measure we call adjusted operating income to measure the performance of our financial services businesses. Adjusted operating income excludes net investment gains and losses as adjusted and related charges and adjustments as well as results from divested businesses.

Adjusted operating income also excludes reported changes in asset values that will ultimately accrue to contract holders and reported changes in contract holder liabilities resulting from changes in related asset values. The comparable GAAP presentation and the reconciliation between the two for the first quarter are set out in our earnings press release on our website. Additional historical information relating to the Company's financial performance is also located on our website.

Today's participants are John Strangfeld, CEO; Mark Grier, Vice Chairman; Rich Carbone, Chief Financial Officer; Peter Sayre, Controller and Principal Accounting Officer; Bernard Winograd, Head of Domestic Businesses; and Ed Baird, Head of International. John?

Good morning, everyone, and welcome. Market conditions were challenging in the first quarter and had an unfavorable effect on our results. Net income for the quarter declined significantly and adjusted operating income was $1.65 per share versus $1.83 a year ago. You can be sure that we're not satisfied with these results, at the same time we are confident that we are on track to achieve earnings over time that are consistent with our long-term goals.

Our businesses are well positioned in attractive markets, our investment portfolio is solid and our capital position is strong. Rich and Mark will walk you through the details in a moment, but now I'd like to take this opportunity to comment at a high level on our earnings.

First-quarter net income declined significantly because below the line items nearly offset adjusted operating income. Net income included the loss attributable to our commercial mortgage securitization business previously included within our Asset Management segment. We are exiting this business. Our decision was driven not only by the current market environment and the associated volatility, but also because the business case for this activity was not proving out.

In addition, we recorded significant realized investment losses that resulted primarily from accounting rules. The rules are the rules and we abide by them, but we would add our name to the list of companies expressing concern that some of the marks may understate true economic value. That said, accounting driven charges amounted to roughly $600 million whereas actual credit-related losses amounted to less than $100 million.

First-quarter adjusted operating income includes transition costs associated or related to the integration of AG Edwards into Wachovia Securities. In addition, some unusual items, mostly related to unfavorable market conditions, were a drag on adjusted operating income. Excluding the impact of unusual or potentially nonrecurring items from first-quarter adjusted operating income in both years, we believe our EPS increased modestly.

Finally, I'll address guidance. Our earnings guidance for the full year is unchanged. Based on adjusted operating income we continue to expect Prudential's 2008 common stock earnings per share to fall within a range of $7.50 to $7.80. As usual, this guidance reflects our consideration of a wide range of circumstances and a few key assumptions.

First, we assume that equity markets, as measured by the S&P 500 index, appreciate 2% in each quarter over the balance of the year. The average level of the S&P for the year would be 1370 if our assumption of 2% appreciation per quarter comes to pass. Our previous guidance assumes stable markets from January 31, and would have resulted in an average level of 1380 for the year.

Second, we expect that our share of the transition costs for the integration of AG Edwards into the Wachovia retail brokerage joint venture will stay at the first-quarter's level, roughly $0.08 a share after-tax.

And third, we expect to repurchase common stock in line with our Board authorization to repurchase up to $3.5 billion for the full year. Of course, we review repurchase activity with the Board every quarter.

Now Rich and Mark will walk you through the details and then we will welcome your questions. Rich?

Thank you, John. I'll comment first on net income and the investment portfolio before moving on to adjusted operating income of the financial services businesses. As you heard from John, net income for the financial services businesses declined significantly for the quarter as impairments and other below the line items nearly offset the operating results of the businesses. This compares to net income of $1 billion or $2.18 per share a year ago.

As you saw in our earnings release, we made a change in our definition of adjusted operating income for externally managed investments in the European market to be more consistent with our general account investments. In addition, as a result of our decision to exit the commercial mortgage securitization business, results of that business have been reclassified to divested businesses.

As a result the mark to market on the European securities and the results of the commercial mortgage securitization business affect our reported net income, but no longer affect our business segment results. We believe this treatment provides a more meaningful measure of our adjusted operating income and one that will be more comparable between periods.

As a result of this change current quarter results for divested businesses include pre-tax losses of $107 million for the commercial mortgage securitization business including exit costs which were insignificant. The loss is mainly a result of widening credit spreads of assets we held during the quarter after the effect of hedging. Our remaining exposure in this business at March 31st, including loans held for sale in retained bonds, net of hedges is about $160 million. Our decision to exit was based on our conclusion that the business case simply did not prove out.

Now I'll move on to the investment portfolio. Current quarter GAAP pre-tax income includes realized net investment losses of $678 million. This compares to net realized gains of $140 million a year ago. Please remember that accounting designation realized doesn't necessarily refer to actual cash or credit loss. In fact, actual credit losses are estimated at $87 million this quarter.

I'm going to build to the $678 million of realized investment losses in four parts -- mark to market on the externally managed European fixed-income investments; other than temporary fixed income impairments; other than temporary equity impairments; and lastly, realized credit losses from sales. I'm going to further break down the fixed income impairments between accounting driven charges and actual credit losses and then further break out the subprime portion of those impairments.

As I mentioned earlier, mark to market results on the embedded derivatives of our externally managed European credits have been classified out of adjusted operating income. As a result current quarter realized losses included $208 million representing mark to market losses on these European investments. This is an unrealized loss reflecting continuing widening of spreads in the European credit markets rather than defaults of fundamental credit losses.

We hold these investments through a structure that calls for embedded derivative accounting requiring us to include changes in market value of the derivative in our income statement. The derivative is essentially capturing the spread movement. We view these changes in values similarly to those on securities where the changes in value from spread widening are captured in the mark to market of the bond itself.

Next, declines in value of securities that met the criteria for other than temporary impairment this quarter were $437 million. This amount includes $388 million for fixed maturities and $48 million for equities. In addition, losses on sales of credit impaired securities amounted to $23 million in the quarter.

Current market liquidity issues have contributed to declines in value that trigger the accounting impairments. We believe it's essential to distinguish between impairments that represent credit related loss of contractual cash flows and the impairments that are driven by accounting rules. Included in the $388 million of impairments on fixed maturities was $64 million of credit losses, $46 million of which came from subprime paper.

The remainder of the $388 million or $324 million represents losses from spread widening causing rule driven impairments which under GAAP we now expect will largely be accreted back through net investment income primarily over the next five years. In our 10-K we disclosed that as of year end there were $91 million of 20% or greater declines in value on fixed maturities in the three- to six-month band. Our general guideline is for 20% or greater declines we impair at six months. So how did we get from $91 million to $388 million?

Well, $64 million are the credit losses I just mentioned. The lion's share of the rest represent securities that reached a substantial level of decline in value during the first quarter; in these instances we do not wait six months to impair. Most of this category relates to significant spread widening on some of our subprime holdings that were in the greater than 20% decline but less than three months category at December 31, '07.

Now let's look specifically at how subprime performed. The $388 million of fixed maturities for the quarter include $290 million of impairments taken on subprime holdings, including the $46 million out of the $64 million credit related loss that I just mentioned. We are continuing to carefully monitor the collateral underlying the subprime paper including delinquency rates and cash flows.

Our current estimate of stress case exposure to potential future loss of principal from subprime holdings, assuming no recoveries from monoline insurers, is about $400 million after-tax over a five-year period. This estimate combines paper wrapped by monolines and non-wrapped paper and is somewhat worse than our previous model results based on our current evaluation of expected incident and severity of defaults. Our stress scenario implies a decline in housing prices underlying these securities of 40% from peak to trough; this is similar to our last projection.

Lastly, unrealized losses -- substantially all of the impairments on equities relate to holdings of our Japanese operations and reflect a decline in the Nikkei. Now, there's no bright line under GAAP, but we feel that it's appropriate to record investments for these value declines as called for by our policy. But it's also fair to point out that as long-term holders our focus is on expected cash flow which for the vast majority of these holdings have not significantly changed.

Now moving on to unrealized losses. Our gross unrealized losses on fixed maturities in our general account stood at $3.6 billion at the end of the first quarter. Of this amount roughly $1.1 billion relates to subprime holdings of $7.1 billion total subprime holdings at the end of the quarter. Virtually all of our subprime holdings were priced using third-party pricing services.

These unrealized losses essentially reflect widening of credit spreads. We have experienced some rating agency downgrades during the quarter as the rating agencies are catching up and reviewing these securities after initially directing their attention to CDOs. Our holdings remain substantially all investment grade with about 80% AAA and AA. This compares to about 90% at year end.

At March 31st, the fixed maturity portfolio of the financial services business included roughly $7 billion of commercial mortgage-backed securities; over 90% of these holdings of AAA ratings and gross unrealized losses of $146 million. The remainder of the $3.6 billion of gross unrealized losses on fixed maturities, or $2.3 billion, relates primarily to widening credit spreads on other investment-grade securities. As of the end of the first quarter gross unrealized gains are roughly equal to gross unrealized losses.

Now I've walked you through a lot of numbers, so let me give you some perspective on how we think about our general account portfolio. When we invest our primary concern is to keep our cash inflows and our cash outflows in line while earning an appropriate return rather than market value fluctuations. The reason we seek investments -- for that reason -- excuse me, we seek investments that offer good relative value in relation to the alternatives.

We believe credit risk is more manageable than interest rate risk and our primary focus is on the expected cash flows and underwriting credit quality of our holdings. We are comfortable with the level of risk in our investment portfolio and, given our strong cash flows and liquidity, we have the ability and intent to hold these investments to recovery and realize the economics.

Now I'll move on to several other items affecting our book value and the results of NAOI for the quarter. The decrease in our book value from realized investment losses and divested businesses was more than offset by an increase to our equity resulting from the combination of the AG Edwards business acquired by Wachovia with the retail joint venture we reflect in our financial advisory segment.

As a result of this combination, on January 1, 2008 we recorded a $1 billion increase in our paid in capital reflecting the after-tax gain on exchanging part of our interest in the joint venture as previously constituted and receiving a share of ownership in the AG Edwards business in return plus a value assigned to our rights under the look back option we elected. Because we have the option to restore our ownership back to the 38%, GAAP requires this gain to be recorded directly into book value adding about $2.20 per share to book value but it does not account in net income.

Our election of the look back option establishes a new floor for the value of our investment. This value is now being finalized. If the multiple paid by Wachovia for the AG Edwards business was applied to our investment the additional gain we would recognize on exercise of the put would be around $2 billion after-tax.

Now turning to our adjusted operating income results. We reported common stock earnings per share for the financial services business of $1.65 for the first quarter compared to $1.83 for the year ago quarter based on adjusted operating income. Our current quarter results were affected by the level of equity markets as well as the erratic relationship among markets during the quarter. I'd like to comment on a few items in particular that affect those comparisons.

Equity market levels influenced the amortization of DAC and other items in both our individual life business and affected several items in our annuity business. In our individual life business amortization of DAC and other items, which reflected the 10% decline of the S&P in the first quarter on separate account values, resulted in a negative swing of about $0.03 per share in comparison to a year ago when the S&P was flat for the quarter.

In our annuity business financial market conditions are a driver of our provisions for guaranteed minimum death benefits and income benefits as well as amortization of DAC and other costs. The true-up for actual experience in the quarter, excluding hedging breakage which Mark will discuss later, and excluding market value changes that we capture in our annual unlocking produced a negative swing equal to about $0.04 per share in comparison to a year ago.

Next, a couple of items that reflect market turmoil more than market direction in addition to our hedging results. They include market value changes in a proprietary fixed income fund in our Asset Management business which had a negative impact equal to about $0.05 per share in the quarter. Additionally, an unprecedented credit loss to our retail brokerage client in the listed futures operations of our international investment segment resulted in a charge equal to about $0.03 per share.

Now unrelated to financial market conditions and going the other way, our Group Insurance business did benefit from a catch-up of premiums on a large case that contributed about $0.03 per share to current quarter results. We've also begun -- as John mentioned, we've also begun to absorb our share of the transition cost for the integration of the AG Edwards business into the Wachovia retail brokerage joint venture which we include in our financial advisory segment. These costs resulted in a charge of about $0.08 per share in the quarter.

In contrast -- now I'm talking about our earnings in the first quarter of the prior year. In contrast to our earnings a year ago, which included a net favorable contribution of about $0.10 per share from market sensitive or nonrecurring items. Now Mark Grier will review our business results for the quarter. Mark?

Thank you, John, and thank you, Rich. I'll start with the insurance division. Adjusted operating income from our individual life insurance business was $96 million for the current quarter compared to $101 million a year ago. The amortization of deferred policy acquisition costs and related items was roughly $20 million higher than a year ago. The current quarter downturn in the equity markets was largely responsible for the unfavorable swing in amortization.

In addition, expenses were slightly higher than the level of a year ago and the equity market downturn had a negative effect on our separate account fees during the quarter. On the other hand, mortality experience for the current quarter was more favorable than a year ago. Sales, excluding COLI, amounted to $107 million in the current quarter compared to $141 million a year ago.

Variable life sales were $32 million lower than a year ago. Large case sales tend to have a lumpy pattern and our sales in the year ago quarter, including several large cases from a third-party producer specializing in the high net worth market, represented almost half of our variable life sales for the entire year. The Prudential agent count stood at about 2,400 at the end of the first quarter, down about 70 from a year ago.

Our annuity business reported adjusted operating income of $115 million in the first quarter compared to $166 million a year ago. The adjusted operating income we report for our annuity business includes breakage between changes in the values of our living benefit guarantees and our hedging instruments.

With turbulent financial markets in the first quarter we experienced negative breakage of $17 million after related amortization of DAC and other costs resulting in a negative swing of $24 million in comparison to a year ago. To keep this in perspective I would note that we are hedging the exposure on about $20 billion of account values.

Our hedging program has been highly effective over time. The net of all breakage since we implemented the program in 2005 through the end of the first quarter of this year is essentially zero. In addition, while our annual unlocking for actuarial assumptions and market performance takes place in the third quarter of each year, we true-up our amortization of DAC and other costs as well as the reserves for our guaranteed minimum death and income benefits each quarter to factor in current experience.

As Rich mentioned, the challenging financial market conditions of the first quarter contributed to an unfavorable true-up of $15 million resulting in a negative swing of $22 million in comparison to the similar true-up a year ago. Our gross variable annuity sales for the quarter were $2.8 billion, up modestly from a year ago. Based on eligible premiums nearly half of these sales had one of our highest daily or HD features.

Net variable annuity sales for the quarter were $656 million, our highest quarter ever. The value of our living benefit guarantees becomes dramatically clear in an environment like this and we are benefiting from our position as the only company that offers guarantees based on highest daily value.

In addition to offering an excellent value proposition to retirement minded consumers and their advisors, our transition to these HD features is reducing our risk profile and decreasing our exposure to changes in hedging costs due to the self hedging features incorporated in product design. Essentially for each of the HD features, as well as our earlier GRO, or grow product, the customer agrees to our rebalancing from the selected funds to fixed income investments in support of the guaranty when there are equity market declines. As of the end of the first quarter 40% of our account values with living benefits had this self hedging feature compared to 33% a year earlier.

The Group Insurance business reported adjusted operating income of $90 million in the current quarter, up $39 million from a year ago. The cumulative adjustment of premiums for earlier periods on a large group life case that Rich mentioned contributed $20 million to the current quarter results. The remainder of the increase came primarily from more favorable group disability results and reflects an increase in earned premiums with an essentially unchanged claims ratio.

Group Insurance sales were $226 million in the current quarter, up from $195 million a year ago. More than half of the increase came from group disability business and reflects premiums in exchange for our assumption of existing reserves.

Turning to the investment division -- the retirement segment reported adjusted operating income of $124 million for the current quarter, down $24 million from $148 million a year ago. More than half of the decline was due to a higher level of expenses. In December we acquired $7 billion of full-service account values from Union Bank of California and we are now incurring costs under a transition services agreement while we integrate this business onto our platform. This contributed to the uptick in expenses. This integration is on track for completion later this year.

The remainder of the decrease in adjusted operating income reflected less favorable investment results including $5 million from lower mortgage prepayment income. Gross deposits and sales of full-service retirement business were $4.6 billion for the current quarter compared to $4 billion a year ago. Stripping out participant contributions from the business we acquired in December, gross deposits and sales would be up about 8% from a year ago. New plan sales were $1.3 billion in the quarter, up 14% from a year ago.

We continue to enjoy excellent persistency on our full-service retirement business which was over 95% as of the first quarter, and we registered positive net flows of about $650 million in the quarter. The Asset Management segment had adjusted operating income of $119 million in the current quarter, down $56 million from $175 million a year ago. The decline came mainly from less favorable results from the segment's proprietary investing business.

We co-invest with our institutional clients in funds we manage including fixed income, public equity and real estate strategies, and we record market value changes in our interest in these funds. The negative swing in this performance, including a decline of roughly $30 million in a fixed income fund compared to a $20 million positive a year ago, was the main driver of the downturn in proprietary investing results.

On the other hand, the Asset Management business benefited from higher performance-based fees in comparison to a year ago mainly related to Asian and European real estate funds together with greater Asset Management fees and greater income from securities lending services. These contributions partly offset the downturn in proprietary investing results as well as a higher level of expenses.

The Financial Advisory segment had adjusted operating income of $44 million this quarter compared to $97 million a year ago. This segment reflects our interest in the retail brokerage joint venture with Wachovia.

Wachovia combined the acquired retail securities brokerage business of AG Edwards with the joint venture on January 1st. Prior to the combination we had a 38% share in the joint venture, but our initial share of earnings and transition costs from the date of the combination will be based on a diluted ownership percentage which is in the process of being finalized.

We are now reporting results based on our estimate of the percentage and we don't expect a material impact on results from any difference between the finalized percentage and our estimate. Our estimated share of the joint venture contributed $51 million to the segment's adjusted operating income for the current quarter after absorption of $46 million of transition costs which Rich mentioned earlier.

This compares to a $111 million share in joint venture earnings a year ago. The segment's expenses for retained obligations in the current quarter were $7 million lower than a year ago partly offsetting the impact of the lower joint venture income.

Within our international insurance segment, Gibraltar life's adjusted operating income was $128 million in the current quarter, down $15 million from $143 million a year ago. The decrease came mainly from less favorable mortality and a higher level of expenses in the current quarter was parallel testing of a new claims system a contributing factor to costs.

In addition, DAC amortization was up from a year ago reflecting less favorable persistency. Sales from Gibraltar Life, based on annualized premiums in constant dollars, were $96 million in the current quarter, up from $79 million a year ago. Life advisor sales were $90 million in the current quarter, up 23% from a year ago.

Gibraltar recently began selling a U.S. dollar retirement product similar to one that has been successful for Prudential of Japan since its introduction about three years ago. Current quarter sales at Gibraltar benefited both from the recent introduction of the product and the current strength of the Japanese Yen in relation to the dollar which tends to make U.S. dollar products more attractive to Japanese consumers.

Bank channel distribution contributed $6 million to Gibraltar's sales, both in the current quarter and the year ago quarter, substantially all representing sales of our U.S. dollar fixed annuity product. We believe the bank channel offers a good long-term opportunity for complementary distribution and are investing in further development of this channel, including the transfer of about 80 of Prudential of Japan's Life Planners to Gibraltar's home office as part of the bank channel effort.

Gibraltar's life advisor count stood at just over 6,000 at the end of the current quarter, about 80 higher than a year ago, but down from the year end count. We hold our life advisors to minimum production standards based on semiannual evaluation periods and we experienced some attrition of lower producers during the current quarter as a result of this process. At the same time we are hiring selectively in order to maintain the cost-effectiveness of the life advisor force.

Our Life Planner business, the international insurance operations other than Gibraltar Life, reported adjusted operating income of $285 million for the current quarter, up $16 million from a year ago. The increase tracked continued business growth mainly in Japan and Korea.

Sales from our Life Planner operations, based on annualized premiums in constant dollars, were $233 million in the current quarter compared to $236 million a year ago. Sales in Japan are $161 million for the current quarter compared to $165 million a year ago. Sales for the year ago quarter included $15 million of an increasing term product that offers tax advantages and is popular in the business market in Japan.

Prudential of Japan essentially stopped sales of this product in midyear 2007 because of an anticipated tax law change that could have eliminated the tax advantages. When the tax law changes were recently finalized the tax advantages on this product were partially retained. Although sales have now been resumed, this product contributed a negative swing of $10 million in the comparison to a year ago.

Our Life Planner count in Japan was just over 3,100 at the end of the current quarter, up about 100 from a year ago. Adjusting for the transfer of Life Planners to Gibraltar's home office for expansion of the bank channel that I mentioned, Prudential of Japan's Life Planner count increase would be roughly 6% from a year ago.

For our operations outside of Japan, which mainly represents our Life Planner business in Korea, sales were $72 million in the current quarter, essentially unchanged from a year ago. We continue to face difficult competitive conditions in Korea and our Life Planner count there stood at about 1,560 at the end of the first quarter, roughly equal to the level of a year ago and down slightly from year end. Foreign currency translation was not a major factor in the comparison of our international insurance results due to our currency hedging programs.

The international investment segment reported adjusted operating income of $26 million for the current quarter compared to $62 million a year ago. The segment's listed futures operations had a $19 million credit loss from a brokerage client during the current quarter. In addition, results from the segment's Asset Management operations were down from a year ago when we benefited from strong sales of mutual funds with up-front charges and income from an equity-related investment.

Corporate and other operations reported a loss of $35 million for the current quarter compared to pretax income of $9 million a year ago. The negative swing in results came mainly from a lower contribution from investment income net of interest expense and an increased loss from our real estate and relocation business.

And briefly on the closed block -- the results of the closed block business are associated with our Class B stock. The closed block business reported a loss of $8 million for the current quarter compared to net income of $95 million a year ago. The current quarter loss reflects $110 million of pretax net realized investment losses, including $230 million of losses from impairments in sales of credit-related securities which were partly offset by gains on sales of bonds. We measure results for the closed block business only based on GAAP.

Turning back to the financial service businesses -- financial services business and wrapping up. There was a lot going on in the first quarter as our businesses and accounting results both reflected the effects of a slowing economy, a very high level of uncertainty and some important dislocations in the financial markets. We have presented our view of our investment portfolio and the underlying credit quality and cash flow prospects which were largely unaffected by the recent financial market conditions, but which did significantly affect net income.

We have maintained our guidance, we continue to manage from a position of capital strength and we remain confident in the fundamentals of our businesses. Underlying performance remains strong and we continue to believe that we're on track to achieve longer-term growth and return objectives that are consistent with our earnings power.

We are encouraged by the staying power of the value propositions that support our business initiatives and we look forward to the opportunities that we have to serve clients and benefit from financial opportunities in these markets.

We add value now as a direct lender, benefiting from the collapse of some of the financing options in the market and we add value to clients by taking and managing risk. And in these respects we are building even more earnings power. Thank you for your interest in Prudential and we look forward to your questions.

(OPERATOR INSTRUCTIONS). Suneet Kamath, Sanford Bernstein.

Thank you. Just a couple of questions. First, on the subprime, I guess you've raised your loss expectation from $300 million to $400 million assuming no bond wraps. A couple things. First, just a little bit more insight in terms of what drove that? It seems like order of magnitude a small increase, but I just want to understand what you're seeing that you didn't see a couple quarters ago.

And then related to that, does that $400 million include what I calculate to be roughly $55 million of credit impairments that you've already recorded both in the first quarter and I think the fourth quarter of last year?

And then a second question on excess capital, obviously in the past you've talked about the ability to lever up the balance sheet using hybrid securities and use those funds to continue your share buyback. At what point do you really need to pull that lever in terms of sustaining the buybacks at $3.5 billion? Clearly you're doing it now with operating earnings and existing excess capital, but at what point do you think you have to actually pull the trigger on the hybrids? Thanks.

This is Rich. Let me take that in reverse order. Let's take the hybrids. Commencing in the second quarter and maybe spilling over into the third we're going to have to access the hybrid market in order to complete or continue our buyback program. Second, on the $400 million, the $400 million does not include credit losses taken to date and it is not a projection or an expected loss. It's a scenario that comes out of a stress test.

It increased from about $300 million after-tax the last time to $400 million today because as we went through the model we felt that the trough during which equity -- excuse me, real estate prices would be down by that implied 40% would last longer. Because it would last longer there would be more foreclosures during that time so the level and the incident of those foreclosures would be greater and that's what drove the lion's share of the increase from $300 million to $100 million.

Rich, can I just follow-up on the hybrids? Given pricing in the market right now do you think that you can execute hybrid transactions with a reasonable economic cost over the next few quarters?

It's less than the cost of equity. I can't define reasonable. We're looking at that carefully.

Okay, thanks.

Nigel Dally, Morgan Stanley.

Firstly (inaudible) mortgage conduit business, last quarter you commented that you could temporarily exit the market and reenter when market conditions improve. What changed and made you decide that the business case no longer makes sense? And then second, just on corporate, results continue to be negatively impacted by your real estate relocation business. How patient are you with that business? At some point doesn't it make sense to either sell it or just shut it down given those operations continue to be a drag on your earnings? Thanks.

Nigel, John Strangfeld here. Let me start with the first part of the mortgage question. Firstly, I want to make sure we provide some context around this. We are a large and will continue to be a very large participant in the commercial mortgage marketplace. We have very distinctive origination capabilities and very, very strong underwriting capabilities and we like the asset class.

Keeping in mind that annually what we originate -- or in '07 we originated about $14 billion of commercial mortgages. Half of that, $7 billion, was for a general account, a quarter of that was agency related and then a quarter of that was the conduit related. So it's that third component representing about 25% of our activity that we made a decision to exit. Part of that had to do with volatility, but also part of that had to do with our perception of the business case and I'd like Bernard Winograd to comment briefly on the business case.

Just to elaborate a little bit about that, I mean the volatility I think and the results of recent quarters speak for themselves. But the longer-term issue from our perspective was the original premise here was that it was another way for us to commercialize the credit skills we have in the commercial mortgage space, which we've done in other ways such as the Fannie Mae and FHA lending, and working for third parties.

And what we discovered -- what has unfortunately occurred over time is that it's pretty clear that in the securitization market for commercial mortgages there's very little measurable differentiation between the offerings of a firm that does a good job of underwriting mortgage portfolios and those that are more aggressive.

And while we've looked hard for the market environment in which we would get paid for our commercial mortgage underwriting skills, we haven't found it and we concluded it was unlikely to arise and therefore we have that long-term basic view that we're not getting really paid for our skills here as much as we were just simply participating in a market that is very unlike what we do in the rest of our investment business where we're managing money for third parties.

And when you add in the volatility and the inefficiency of the hedging that the recent market environment has made manifest, the decision seemed pretty straightforward.

Nigel, it's Mark on your second question. The answer is that we have been and will continue to be I guess what you describe is very patient with our real estate and relocation business. Obviously in the midst of an extremely harsh cycle in housing they've experienced a downturn in earnings; the other side of that is they've done very well in recent years as the housing market has been so strong.

These are very high-quality businesses and our brand is intertwined with these businesses going both directions. They have a strong affinity for the Prudential brand and they are important to us in the visibility and presence of our brand in a lot of places and in a lot of important ways. Actually the brand value of these franchises is meaningful. So we will continue to be patient recognizing the cyclicality and expecting that they will come back when the market comes back.

That's helpful. Thanks.

Tom Gallagher, Credit Suisse.

Good morning. First question for Rich. I just want to make sure I understood your comment on the value of the put option to sell your stake in the Wachovia JV at market value. Did you say that was $2 billion above where you're currently carrying it on your balance sheet and will that have any impact on your balance sheet if that is correct?

That is correct. It's not the put option per se, it is the value of the enterprise underneath the put option.

And so, Rich, will there be any recognition of that on the balance sheet, or is that only if you exercise the put option?

Only when we exercise -- when and if we exercise, excuse me.

So we should think about this as being -- I believe it's -- $1.4 billion is the cost on the balance sheet, add $2 billion to your current estimate and market value is roughly $3.4 million?

No, because you've got to remember, we just wrote up the balance sheet by the gain that I put directly into paid in capital. And the gross value of what I put into paid in capital was 1.6. So the carrying value today is $2.8 billion. And then in addition to that -- you would add the $2 billion on top of that.

So your estimate today for the value of that would be 4.8?

I wouldn't (inaudible) point estimate on that. I think the range of 45 billion is probably right.

Okay.

Rich's numbers just used a benchmark multiple from the recent transaction.

Okay, so this is just something using recent third-party transactions. Should we take this or at least the market value in your estimate as any sign or indication of what your intention might be for that business? And maybe you can comment and what your intention is for that business? Thanks.

Tom, John Strangfeld here. You should not take that as a statement of our intention of the business. You know, what we have at this point is an attractive look back feature. What we are in is the early phases of the integration of -- with the JV which we believe will go well. This is a very experienced management team. So we continue to think we have an investment here with a very attractive upside associated with a strong management team and yet the downside protections associated with a put.

And the value of this investment, Tom, is not reflected in our balance sheet today.

Understood. The other question I had was -- so you are now counting the CMBS conduit as a discontinued operation. Can you comment on what the amount outstanding on that is as of today and what your intentions are? Or I presume that means you're going to unwind it or sell it, but how should we think about that?

You may recall that at the end of the year we said that the assets of this business were order of magnitude net of hedging about $750 million. At the moment the comparable number would be about $160 million. The gross assets that are behind it that are still on our balance sheet are about $430 million of bonds that we retained from securitizations and about $420 million of loans that were in our pipeline before we could complete a securitization. We're not going to attempt to sell this as a going concern. We will work our way out of those positions over time as the market permits.

Okay. So, Bernard, we have $430 million of gross, $160 million net -- I presume as we get to the end of next quarter that might be completely unwound, is that fair to say?

Well, it's $430 million gross of bonds, there's another $420 million of loans. So it's $850 million gross, $160 million net of hedges. There's always the basis risk in the hedges. As for the timing of when we'll be able to finally liquidate those positions, we're not prepared to talk about that just yet.

Okay, thanks.

Andrew Kligerman, UBS.

Good morning. Maybe you could help me a little bit on the OTTI. I think, Rich, you were saying that there were some securities that were down in value over a three-month period and you decided to take the impairments now. How does that reconcile with your view -- first, maybe a little clarity around it. And secondly, how does that reconcile with your view that it probably will reverse over the next five years?

And then the second question or second area would be it seems that in Korea there's a struggle again with the agent base retention, etc. Perhaps a little color on how you see that going moving forward?

Let me take the first one. Let me give you the criteria we use for impairment and it's not quite as loose as we decide. We have four criteria for impairment. First is the lack of intent to hold to recovery. The second would be if a security is down more than 20% for more than six months we impair it. If a security is down more than 50%, regardless of its time frame, we impair it. And if we are doubtful about a security's cash flow we impair it and in that case we'll characterize it as a credit loss.

Okay. So there were securities that were down more than 50% or you had doubts about the cash flow so you just took the impairments?

It was the former. It was securities that were down more than 50% and they came down more than 50% during the quarter.

And even though you feel that it could reverse, you felt it was more appropriate or more conservative to just take the hit now, is that right?

I don't think it's more appropriate or conservative. The SEC and the FASB is clear about this -- other than temporary does not mean permanent, it only means other than temporary. And so when that security is down for more than six months or more than 50%, under our rules we treat that as other than temporary. (multiple speakers) back through income because we believe the cash flow is solid.

Andrew, I think to part of the point you're asking, we're very rigorous in this. We don't exercise judgment and decide not to impair something because it looks different even though it meets the rule. If it meets the rule it's impaired. So we're very clear about it. I think part of Rich's discussion was designed to help you guys understand how rigorous we are and to make it clear to you that we follow these rules strictly as it relates to all these asset decisions.

Okay, that makes (inaudible) because some of your competitors may be a little less rigorous and I just was interested in the insight there and thank you for it.

And on the second question, Ed Baird will speak to Korea.

Yes, regarding Korea, you're right, we have seen a resurgence of [poaching]. And to refresh people's memory we saw this about two years ago in '06, quite a bit of it. We addressed that in some ways during '07 and so we saw a substantial abating of it throughout '07. This quarter we've seen an uptick in it, not to the same level that we saw in '06 and of a slightly different character in that the targeting seems to be more towards the management as opposed to directly Life Planners.

Needless to say, those managers in turn dragged with them some life planners. So we will be taking actions -- it's already started -- that are designed to address the management issues as opposed to the Life Planner issues last year. But you're right, this market continues to be very competitive and highly dynamic.

Thank you.

Jimmy Bhullar, JPMorgan.

Thank you. I have a couple of questions. The first one is just on capital. If you can talk about your comfort with the ongoing buyback at the $3.5 billion annual base. Some of your competitors have actually been cautious on capital given the current equity incurred market conditions. Are their certain areas in which you would slow buybacks? If you can talk about that.

And then secondly, just your outlook for Japan's sales given high competition in the market which I'm assuming is a negative, but also you've resumed sales of the increasing term product which should help. What do you think your sales are going to be like in the (inaudible) Japan business over the rest of the year?

This is John. Let me take the first one. Our view on this is we're staying the course on the buybacks. What would cause us to change is if we saw an attractive acquisition or a need to invest heavily in the business beyond what we've experienced in the past, or if we had an asset quality concern. And we see neither of the above. It's something we review quarterly with the Board and our intention is to stay the course. On the --

Jimmy, let me -- it's Eric. You know us well enough to know that we would be reluctant to give you a projection on --

But just generally if you could talk about how sales are going to trend from here. I think they were down about 1% this quarter, but --?

Generally our sales have tracked the rate of growth in life planners over long periods of time with leads and lags from trend line affecting new product introduction and pricing changes and such and that's about as much as we want to say today.

Okay, thank you.

Ed Spehar, Merrill Lynch.

Good morning. I had a few questions. First, Rich, I was wondering if we could go into a little bit the operating earnings impact from the impairment actions? I guess if I look at the bonds that were impaired that you sort of considered one of the accounting impairment -- the $324 million. Should I be looking at that as basically an additional $0.10 a share in operating earnings for the next five years if that's coming back in through an accretion of the discount I guess?

Ed, I can't tell you if it's $0.10, but the $324 million, as long as -- it's not the entire $324 million, it's the lion's share of the $324 million -- will come back into income over the remaining maturity of the underlying bonds on a straight line basis. I would suspect if these numbers become material we'll disclose that amount.

Okay. And a related question, I mean it seems like if I just use the five years -- we can do the math, I think it's pretty close. But I guess the other question I have is on this sort of impairment methodology. You say you don't have a bright line test, but you sort of do, don't you? It seems pretty bright to me and I guess the question is this.

No one seems to be calling for this, but what happens in an environment where we decide that there's inflation and rates go by 300 to 400 basis points, so treasuries are up 300 or 400 basis points? Let's just say for the sake of argument you've got a six-year duration portfolio, I mean you could have your entire book at more than 20% below cost.

I said that GAAP has no bright line. It leaves it up to the issuer, the registrant to pick what they believe is appropriate for their portfolio. We pick the rules, I explained before, and they are bright lines to us.

As far as your other question goes, that asset is other than temporary, I think I made that point. The SEC and FASB, other than temporary does not mean permanent. So if it's a treasury and it's under water for more than 20% for more than 6 months it will be impaired and be accreted back into income. The theory being that that bond has been impaired economically and what they've done is they've fixed the balance sheet and fixed the income statement by accreting back through the income statement the appropriate yield for the fair value of that bond.

Rich, I guess I don't get that when you're talking about a treasury-related change because then there's an equal change in the fair value of the liabilities as well. This is credit spread we're talking about now. I guess I find it really hard to see that -- I mean you would really impair the entire bond portfolio if it was a spike up in rates because of inflation?

I would suspect at that point in time there would be an EITF or an SOP that got issued that amended that. But as it exists now those are the rules.

Okay, and then one last question. On Life Planner sales -- I think I might have missed this, but can you, Mark, maybe tell me if you adjust the first quarter of last year for a couple of things that maybe boosted sales then, what are you looking at as sort of the underlying growth rate in Life Planner sales in the first quarter?

This is Ed, I'll take the question for you. There were two factors that significantly influenced Life Planner sales in the first quarter of last year which you may recall was up about a full 10% year-over-year, in other words versus the '06. One was on the increasing term product; that had constituted about $15 million first quarter of '07. In the first quarter of this year it is at $5 million, so that was a net of $10 million.

In fact, in the intervening quarters, for the reason mentioned about the tax uncertainty, it had virtually dropped to zero. So it's back up to of about 5. Because of the partial recognition of the tax credits we expect that could continue, but we're really not sure because it's not the same tax status as it had been.

Secondly, at this time last year there was an announcement of a repricing on the U.S. dollar retirement product and consequently, as often happens in those situations, it was something of a fire sale of the product. That has dropped about $11 million from this time last year to this quarter. So if you look at the all other with those two exclusions what you'll see is it went from about $87 million to $104 million.

Thank you.

Colin Devine, Citigroup.

Good morning. A couple questions on the investment portfolio and capital management. Rich, based on what you said, you're getting to the end of your excess capital on hand to fund a buyback. So did I understand you right, that if you can't get some sort of hybrid offering off this quarter that you might have to stop the buyback? That's question one.

Then question two, turning to the investment portfolio, the comment you like credit risk and you don't like interest rate risk -- perhaps you could reconcile the very large exposure that's well above average in the subprime MBS with respect to that.

And then also, my impression was that -- I guess from Mark's comments, that given some of the opportunities in the world right now you're looking to add risk to the portfolio to take advantage of some of them. How can you do that when you've got one of the highest risk portfolios in the industry today?

Okay, on the buybacks, Colin, we will need to access -- the hybrid market is operating and we'll need to access the hybrid market in the second and third and fourth quarter in order to complete our buyback program.

Okay. And if you were not you would need to suspend it, is that what you're saying?

Well, operating cash flows -- we've always said we're striving for the optimal capital structure. And to get to the optimal capital structure of 70% equity, 20% debt, 10% hybrids, that's what it allows us to buy back stock. So the answer to your question is, yes.

Thank you.

Colin, it's Mark. I'm going to answer your third question and then we'll get more specifically on subprime with Bernard. First of all, we have a difference of opinion about whether or not we have an extremely risky portfolio. We've gone through it in quite a lot of detail on this call and in other disclosures and I guess we'll agree to disagree. But I want to make the point that we don't believe that we have a significantly riskier portfolio than others.

My comment about our positioning as a direct lender and the opportunity that we have to benefit from the collapse of other financing options was not meant to imply that we're out there looking for risk. In fact, the opposite is true. The flows to our direct lending businesses are now higher quality, these are the deals that would have been picked off by the conduit type structured issuers. They are higher quality deals with better terms meaning better prices and better covenants.

And the point of that is we really have the opportunity to do less risky business at more attractive terms because we are a direct cash lender in the markets that have been affected by the collapse of the alternative financing vehicles. So we're not on a binge here trying to add risk, we're trying to take advantage of things that play very well with our core strengths and our own direct origination capability and, again, in fact reflect higher quality business, lower risk and better terms than we have seen in a long time in some of these channels.

But then, Mark, are you saying then that we should expect your below investment-grade holdings, which are certainly above average relative to the peers, to start coming down or your exposure to equities, which is also above average relative to the peers, to start to come down because you're just able to get better higher quality corporate bonds? Or are you going to increase your commercial mortgage exposure? Where's the portfolio going?

Right now the best opportunities for us are in the direct lending activities in Pru Capital and in the mortgage business and we're very comfortable with the asset quality in both of those portfolios. We have not broadly changed our asset mix targets here in a long time, reflecting by the way years of a conservative view on the U.S. credit and capital markets.

And I would not want to signal at this point any anticipation that we would change our broader asset mix objectives, but again, we do see very high-quality flows into our direct lending businesses in Pru Capital and in the mortgage business. And Bernard and John may want to comment further.

Let me just give you an example of what Mark's comment is about. It's taking advantage of the marketplace, it's not necessarily taking sizable risk. In the commercial mortgage market we recently circled a transaction that had this multi hundred million dollar commercial mortgage on a high-quality retail mall that had a loan to value ratio in the 40s and had debt service coverages over 200%. And most people would agree that's a very conservative underwriting profile.

A year ago that transaction would have been done by a conduit, we would not have seen it and the spread would have been under 100 basis points, probably in the 90s, and we circled that transaction recently at over 325 basis points. So it's an example of with the withdrawal of the securitization market that the gap that it's left has provided material opportunities in the investment-grade sector, not simply in the higher risk categories. Bernard?

I'd just add on that point and then I'll speak to the subprime investment position. I'd just add on that point that it is one of the ways, one of the things that is distinctive about our investment capabilities is that we have very substantial direct lending capabilities, particularly in the private loan -- private loans made directly to commercial companies. That allows us to get a familiarity with management.

Much of all we do, about half of what we do are repeat loans to companies and -- that we have followed for years and have built relationships with. And so where we take risk, to some extent it's mitigated by the fact that we tend to do it in private markets where we have more insight and where the pricing is a little less efficient and there's a little less competition from the covenant free public market environment.

Now the subprime story is a slightly different issue because there we're clearly buying securities that were sold in the public marketplace and I think it's actually exemplary of our basic underwriting discipline. We look, first of all, as Rich said, our primary focus is on our ability to get repaid rather than having a view of what the fluctuations in value are likely to be in the short run. And our basic investment discipline is all about looking at, in that universe of what's available, what looks cheap and what looks expensive, avoiding the expensive and buying the cheap.

And for some time now, for the better part of two years, there are parts of the subprime market that have looked cheap to us and we have built a position in those, even while we were simultaneously shorting in portfolios where we have that luxury for third parties, while we were simultaneously shorting some subprime securities that we felt were egregiously overpriced and incredibly risky and it's basically that's been the story.

That is why, even though we have a very large number, sort of headline number of exposure, it's a very selective exposure to the parts of the subprime marketplace that we do not think are likely to suffer losses over the long run and where we will get very well paid for holding what we hold.

Bernard, has -- what you've generated off the shorting, has that materially contributing to do Pru's earnings?

No, not materially. It has contributed because, to some extent, it's been in portfolios where we're co-investing alongside clients, but it's not a material number.

Okay, thank you.

And Colin, just on your question about the hybrids -- I might not necessarily have to issue them in the second quarter, but by the third quarter we will need to access that marketplace.

Jeff Schuman, KBW.

Good morning. I'm wondering if Bernard can update us a little bit on the proprietary fixed income investment that generated the big loss for Asset Management in the first quarter? I'm assuming that performance there has improved with the tightening of spreads, but I'm wondering if you can give us some color therein or minus of the size of that investment?

And secondly, I'm wondering about the mortgage paper that is still sitting in the conduit business. I appreciate there's a large hedge against it, but I'm wondering why, given your appetite for commercial mortgages generally at this point, why some of the mortgages and the mortgage paper wouldn't be suitable to market to your general account?

Jeff, this is John. Let me start with that and then turn it over to Bernard. First, just for the broader benefit, I just want to clarify when we say proprietary investing what we mean by that. Because I know that this can conjure up in people's minds all sorts of things. We want to be clear what this is and what this isn't.

It is not some sort of stand-alone trading activity. For us what proprietary investing has to do with is co-investing with our clients either in fixed income or real estate or other asset classes. It's part of our institutional Asset Management activity. And our total amount of co-investing or proprietary investing, I should say, is about $2.2 billion and that's alongside, in those cases, around $11 billion of client assets.

So that's the context for this. It's not some discrete activity, it's investing alongside of our clients. And insofar as the specifics on the fixed income, let me turn that over to Bernard.

I don't know that -- it would be a very long answer to try to get into the specifics of what was going on in that particular fund which represents about 20% or so of the total portfolio co-investing we do alongside clients. It is a fund which has an objective of beating LIBOR by about 500 basis points and having an information ratio of about 1. But it's safe to say that much of the volatility here in that fund was driven by the sort of disconnects between the derivatives markets and the cash markets, particularly in the last couple weeks of March, that have affected a lot of people.

The conduit paper question, we did actually look at the question of whether the general account wanted to own any of the paper that had been lined up for securitization and in particular any of the loans that had been lined up for securitization. And we did transfer about $200 million of it to the general account at fair value during the course of the first quarter. At fair value it was attractive, so in effect for their portfolio and their portfolio constraints around diversification and credit levels and what have you, there was a portion of that paper that fit their investment needs and we did make that transfer at fair value.

Okay, thank you very much.

That does conclude the question-and-answer portion of our conference. Mr. Strangfeld, please continue.

Thank you. Let me just sum up by saying that Prudential is in good shape. We are comfortable with the quality of our investment portfolio, our capital position is extremely strong. We believe our businesses are well-positioned in attractive markets with the earning power to meet our long-term expectations in a normal environment. We're confident, we're not content and we believe our best days lie ahead. Thank you very much for joining the call. Have a good day.

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