Fitch Affirms Prudential Ratings

Fitch Ratings affirmed U.S. life insurer Prudential Financial Inc.’s ( PRU - Analyst Report ) issuer default rating (“IDR”) and insurer financial strength (“IFS”) ratings last week. The rating agency affirmed an IDR of “A-“and an IFS rating of “A+”.

Prudential Financial’s operating results, debt servicing capability, capital strength and reliance on both short and long-term external debt were the factorstaken into account by the rating agency prior to the ratings affirmation.

With regard to operating results, the rating agency noted that Prudential’s Financial Services Business generated higher income in fiscal year 2011 compared with fiscal 2010. The higher operating income was led by better performance from its high growth international, asset management and other segments, partially offset by a decline in the annuity and group segment businesses.

Profitability, as measured by average return on assets, declined 9 basis points year over year to 0.62% in fiscal year 2011, due to reduced income from the company’s Closed Block segment coupled with a high denominator in the form of increased assets.

Debt service capability, as measured by interest coverage, stood at 6.0x, as of December 31, 2011, which falls in the run rate range of 6.0x to 7.0x.

As far as reliance on external debt is concerned, Fitch noted that Prudential has reduced its commercial paper borrowing to $1.2 billion or 4% of total debt as of December 31, 2011, down from 5% as of December 31, 2010. The company’s short-term debt level also lies within the rating agency’s cut-off limit of 10%.

On the flip side, Prudential’s high financial leverage ratio of 32% continues to be a cause of concern for the rating agency. The rating agency also pointed out that the company’s efforts to lower its debt levels are progressing slowly. It was also concerned with the company’s Total Leverage of 42% and Total Financing and Commitments ratio of 1.3x, which were above its peer average due to high use of debt within the insurer’s capital structure.

Nevertheless, Prudential’s robust statutory capitalization of 494% as of December 31, 2011 at its Life insurance units gives the rating agency adequate confidence in the company. Its Japanese operations also hold statutory capital way above the minimum required levels.

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; if commercial paper holding increases above 10% of the total debt; interest coverage ratio falls below 5%; total financing and commitments ratio increase above 1.5x; NAIC RBC falls below 400% and Japanese solvency margin ratio falls below 600%.

A rating upgrade can be accompanied by reduction in Commercial paper holdings, bringing down the leverage ratio to mid 20% and total leverage to under 40% maintaining interest coverage ratio at 8x-10x range and holding NAIC statutory capital near the current level and Japanese subsidiaries’ risk-based capital above 700%.

In our view, a rating downgrade in the near term is unlikely. 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.

Peer American International Group Inc.’s ( AIG - Analyst Report ) Issuer Default Rating was affirmed at “BBB” and was upgraded to positive from stable by Fitch earlier during the year reflecting the insurer’s niche presence in several key markets. Its Insurer Financial Strength rating was also affirmed at “A” with a stable outlook.