MetLife’s Buybacks Announcement Signals End of Bunker Capital Strategy

MetLife (NYSE: MET  ) is the largest life insurer in the U.S. and is a leading provider of individual and group insurance, annuities, corporate benefit funding solutions, and auto & home insurance. The New York based insurer has a diversified, international platform with advantages of economies of scale and a well-known brand.

MetLife is shifting its business mix to less capital intensive products, which should help to increase cash flow. Moreover, investors should look forward to growth accelerating in 2015, as investment spending declines, cost savings emerge, and international earnings improve.

Share buybacks a positive surprise
MetLife announced recently that it will repurchase $1.0 billion of common stock utilizing its existing authorizations. Most investors were not anticipating any share repurchases until 2015, so this news comes as a huge positive surprise for investors. 

Previously, the insurer had refrained from buybacks as it waits for more clarity on Federal Reserve's non-bank systemically important financial institution (SIFI) designation/rules. However, the company's patience in waiting for clarity on capital rules came to an end, leading to an announcement of $1.0 billion shares buyback program.

Commenting on the buybacks, CEO Steven Kandarian said, "We anticipated that the non-bank SIFI (systemically important financial institution) capital rules would be known by now, but recent statements by the Federal Reserve suggest that we may not see draft rules until 2015." 

He further added, "Our philosophy is that excess capital belongs to our shareholders. The challenge is to strike the right balance between adherence to our philosophy and recognition that MetLife's required capital levels remain unknown."

While The Federal Reserve is authorized to regulate American International Group (NYSE: AIG  ) and Prudential Financial (NYSE: PRU  ) after the Financial Stability Council designated them non-bank SIFI last year, MetLife is not yet designated a systemically important financial institution, whose failure could post a threat to United States' financial stability. The New York based MetLife is in the final stage of consideration to be designated systemically important.

While the insurance company's plans to initially purchase $1 billion of shares are modest relative to its capital base, it sends a positive signal and also offset dilution from a $1 billion conversion of equity units maturing in October related to the American Life Insurance Co. acquisition in 2010 . I think MetLife will wait for more clarity on SIFI rules before announcing additional buybacks. However, if draft rules are not published in early 2015 as anticipated, MetLife could act in advance.

89% increase in annual dividends since 2013
Buybacks are not the only way the company is returning cash to shareholders.

Since early 2013, MetLife has increased its annual dividend by 89%. The insurance company has a dividend yield of 2.5%, compared to 0.9% of American International Group and 2.4% of Prudential Financial. MetLife currently has a dividend payout ratio of ~25% of operating income.

Fed-regulated banks face a limit on dividend payout ratios at 30% of net income, but MetLife is hopeful that instead of net income the Fed will consider operating earnings for life insurers, which are more indicative of true earnings generation. While the insurance company has previously said that it favors dividend over buybacks because of the smaller outlay, the likely Fed regulation means that MetLife's growth in capital deployment will be more from share buybacks than dividend increases.

On track to save $1 billion
MetLife also remains on track to achieve its $1.0 billion of gross expense savings by 2015. Out of this $1.0 billion, the company plans to reinvest $400 million in the business for new capabilities and technology to become more efficient and more customer centric company. One area of expense savings opportunity is data centers; MetLife currently has 93 data centers that are being consolidated into 6 locations with the American Life Insurance Co. acquisition being a primary driver.

Foolish takeaway
MetLife largely surprised the markets by making $1.0 billion shares buyback announcement. The insurer has previously been hesitant to repurchase shares because of the concerns that non-bank SIFI capital rules may be onerous especially if bank-centric Basel III capital rules are applied.

However, with Senate recently unanimously passing a bill , which allows the Fed to apply distinct capital standards for insurers (namely American International Group, MetLife, and Prudential Financial), and the appointment of Tom Sullivan to head Fed insurance regulation, gave MetLife enough confidence that rules are unlikely to be a disaster for the insurance companies, hence a modest buyback announcement from MetLife. 

While the $1.0 billion buybacks only represent 1.6% of MetLife's current market cap, the announcement has more symbolic and directional positive value for the company, as it is likely to represent the end of MetLife's bunker capital strategy and the beginning of a more balanced strategy that will consider dividends, buybacks, and mergers & acquisitions.

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