Fitch Affirms Principal's Ratings

Fitch Ratings reiterated long-term Issuer Defaults Rating (“IDR”) at 'A’ of Principal Financial Group Inc. (PFG - Analyst Report). Concurrently, the rating agency also reiterated the Insurer Financial Strength (“IFS”) at ‘AA-’ of Principal’s operating subsidiaries. The outlook of the ratings remains stable.

The affirmations came on the back of better operational results, solid capitalization, and moderate financial leverage. However, increased exposure to direct mortgages and structured mortgage securities dwarf these positives.

Principal Life Insurance Company, the main insurance operating subsidiary largely aids Principal Financial to maintain a solid capitalization. Principal Life’s risk-based capital ratio at 2011 end was 449%, up from 420% at 2010 end.

The company also has a modest financial leverage, 16% at the end of the first quarter of 2012 with cash and equivalents of $378 million.

Though Principal Financial reported higher operating earnings in 2011 (increasing 7% year over year attributable to higher fee income), its premiums went down due to divestiture of the group medical business.

Fitch noted Principal Financial is focusing on its fee-based businesses, which will help it to weather the shortfall in earnings owing to the divesture of its heath insurance and cut down in its institutional spread business.

However, Fitch stated that it might consider rating upgrades if Principal Financial maintains a return on equity of 10% or higher, stability in earnings and capital, continues to grow international operations and risk-based capital ratio remains above 475%.

Ratings might be subject to downgrade if investment losses amplify, return on equity falls below 6%, fixed charge coverage ratio drops below 5x, risk-based capital ratio falls below 350% and financial leverage goes beyond 25%.

Rating affirmations or upgrades from credit rating agencies play an important part in retaining investor confidence in the stock as well as maintaining creditworthiness in the market. We believe, the company’s strong ratings scores will help retain investor confidence and help it to write more businesses going forward, thereby augmenting the results.

We retain our Neutral recommendation on Principal Financial. The quantitative Zacks #4 Rank (short-term Sell rating) for the company indicates slight downward pressure on the shares over the near term. The compnay competes with Lincoln National Corporation (LNC - Analyst Report).