MetLife (NYSE:MET) has been one of my favorite financial companies that I don't actually own, and nothing has happened to dim my enthusiasm for the company. Not only has the company been fairly proactive in adapting to the new regulatory realities of the U.S. financial system, but it has also looked to improve its international growth prospects while reducing risk in its business. Even though the shares are up 50% over the past year, I'd still consider adding these shares to a portfolio (and would do so in my own portfolio if I didn't already have sizable exposure to the financials).
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Regulation Isn't “If”, It's “When” And “How”
Investors have been fretting over the possibility that MetLife will be declared a systematically important financial institution (SIFI) by U.S regulators, and with that, face higher required capital ratios and considerably more oversight regarding future dividends and share buybacks.
Honestly, “possibility” seems like the wrong word to use. With recent updates from AIG (NYSE:AIG) and Prudential (NYSE:PRU) regarding their likely SIFI status, I think investors would do well to consider non-bank SIFI status a near-certainty. Yes, MetLife completed the sale of its bank operations to General Electric (NYSE:GE), and that deal was motivated by a desire to reduce its regulatory burden, but the reality is that MetLife is still a massive U.S. financial institution. To that end, I really don't see MetLife wasting its time fighting the designation, but rather working with regulators (and perhaps key memb2ers of Congress) to negotiate less onerous terms for that oversight.
At the same time, MetLife seems to be relatively well-positioned with other potential regulatory risks. More and more attention is being paid to captives in the life insurance industry, with New York's Superintendent of Financial Services calling for a nationwide moratorium on the practice. While captives can have a legitimate role in managing parent-group risks, they can also be used to obscure a company's risks and capital and basically circumvent regulation and examination. To that end, while MetLife's captive exposure has been rising over recent years (and is higher than peers like Prudential Financial Group (NYSE:PFG) and Hartford (NYSE:HIG)), it is still quite a bit lower than others like Genworth (NYSE:GNW) or Reinsurance Group (NYSE:RGA) and likely not a major risk.
Little Capital Return Upside In A Capital Return World
As I've written recently in regard to U.S. banks like Fifth Third (Nasdaq:FITB) and U.S. Bancorp (NYSE:USB), capital returns to shareholders (dividends and buybacks) are increasingly important in a low-interest rate, low-loan growth environment where earnings growth is very hard to come by.
It's not so different in life insurance. While MetLife boost its dividend substantially after the sales of its bank assets, the company's capital position after buying Provida likely limits its flexibility for the next year or so. To that end, investors looking for insurance with high capital return potential probably need to look more at RGA, Amerprise (NYSE:AMP), or StanCorp (NYSE:SFG).
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Managing The Business Along Logical Lines
All told, I like how MetLife continues to manage its business. The company's recent discussions of the variable annuity business at its investor day provides one such example.
MetLife has chosen to “de-risk” its variable annuities business largely through price increases and benefit reductions that improve the risk-reward equation for MetLife, while also making the products incrementally less appealing to buyers. This is cheaper than using reinsurance and I think it has better optics than buying out policyholders (as other insurers like Hartford have done). All told, MetLife still likes this business for the long term, and I think management has worked out a compromise that reduces the balance sheet risk without compromising profitability or hurting the company's image.
MetLife also remains well-positioned with respect to interest rates. While the low rate environment has certainly compressed earnings and returns today, MetLife is one of the companies that will benefit if (when?) interest rates pick up again.
SEE: The Industry Handbook Tutorial: The Insurance Industry
The Bottom Line
I believe that MetLife combines a well-run (and well-capitalized) slow-growth insurance and financial services business in North America and Western Europe with a higher-growth operation focused on emerging regions like China, Asia-Pacific, and Latin America. Competition is fierce and accounting rules make the balance sheet pretty murky, but that is the risk investors have to accept in this sector.
I continue to believe that MetLife can produce a long-term ROE of 11% (in the middle of management's 10% to 12% target), and that the company will earn a spread on its cost of capital. Using an excess returns model, fair value appears to be well into the $50s. It's also worth noting that the bank trades at a sharp discount to its historical book value multiple. While some discount to that past multiple is clearly warranted (the company isn't nearly as profitable as it used to be and the world is different), I think the 20% or so upside suggested by the book value makes MetLife a good risk/reward proposition from here.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
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