Fitch Avows Prudential’s Ratings

Last week, Fitch Ratings affirmed the issuer default rating (“IDR”) of ‘A-‘ of the U.S. life insurer Prudential Financial Inc. (PRU). Concurrently, the rating agency affirmed the insurer financial strength (“IFS”) ratings at ‘A+’ of the subsidiaries.

Prudential’s operating results, debt servicing capability, capital strength and diversified business profile were all taken into account by the rating agency for the rating action.

As far as dependence on external debt is concerned, Fitch acknowledged that Prudential has commercial paper borrowing of 3% of total debt as of Mar 31, 2013, 1% higher compared to that of Dec 31, 2012.

Prudential’s short-term debt level lies within the rating agency’s cut-off limit of 10%. Its interest servicing capability has also improved as measured by interest coverage ratio which improved to 11% as of Mar 31, 2013 compared with 6% as of Dec 31, 2012.

Prudential’s robust statutory capitalization of 468% as of Mar 31, 2013, gives the rating agency adequate confidence in the company. Its Japanese operations also hold statutory capital, way above the minimum required levels.

Prudential also has adequate financial flexibility according to the rating agency. With $4.6 billion of cash as of Mar 31, 2013, the company stands far above its minimum target cash level of $1.3 billion. Fitch, however, expects that the company’s cash cover will narrow down though will be maintained well above the minimum target.

Prudential’s investment portfolio is also performing better. Investment related losses have narrowed down and commercial mortgage backed securities have yielded net unrealized gain as of Mar 31, 2013. While the company’s subprime portfolio is a concern, it is on a run-off mode.

On the flip side, Prudential’s high financial leverage ratio of 35% continues to be a cause of concern for the rating agency. It was also apprehensive with reference to the company’s Total Financing and Commitments ratio of 1.5x, which was above its peer group average due to high use of debt within the insurer’s capital structure.

The rating agency has considerable confidence in Prudential, which is attested by the stable outlook accompanying the ratings. A stable outlook reflects that Prudential is experiencing stable financial and market trends, and therefore a rating change in the near term is unlikely.

However, Prudential may face near-term downgrades, if financial leverage ratio breaches the 35% mark; commercial paper holding increases above 10% of the total debt; interest coverage ratio falls below 5%; total financing and commitments ratio increases above 1.5x; NAIC RBC falls below 400% and Japanese solvency margin ratio falls below 600%.

A rating upgrade can be accompanied by a reduction in Commercial paper holdings, bringing down the leverage ratio to mid 20% and total leverage to below 40%, maintaining interest coverage ratio in the range of 8x to10x and holding NAIC statutory capital near the current level, and Japanese subsidiaries’ risk-based capital above 700%.

We believe Prudential is well poised for solid earnings growth and improved return on equities (ROE) led by its superior brand value, an aging American population, strong Japanese operations and a growing international business.

Anther company in the same industry MetLife Inc. (MET) carries an IFS of “AA-” and IDR of “A-” from Fitch.

Prudential’s stock retains a Zacks Rank #3 (Hold). Other stocks CIGNA Corp. (CI), Enstar Group Ltd. (ESGR), both with Zacks Rank #1 (Strong Buy) are worth considering.