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After tough 10 days, Aflac to release earnings Monday

Financial adviser Mike McKay was working on a project Jan. 22 when his phone rang about 10 a.m.

One of his clients asked about Aflac’s New York Stock Exchange price. The stock closed Jan. 21 at $36.27 per share. It opened the next day nearly $4 per share lower and continued to drop like a stone off the Columbus-headquartered company’s Wynnton road tower.

McKay scrambled to check it out because any sudden move - up or down - in Aflac gets his attention. He worked in the company’s marketing department for 17 years before leaving in 2003. He is now with LongView Wealth Management in Atlanta and his client list is loaded with members of the Aflac sales force, past and present.

“My first thought was, ‘Wow,’” McKay said. “Then the phone calls started. From 10 after 10 until 7 at night, I was on the phone with clients. The biggest single question was ‘What’s going on?’ There was no panic; no ‘I have to sell now.’ But they wanted to know what was going on.”

Their concerns were valid. By the time the day was done, Aflac stock lost nearly 37 percent of its value, closing at $22.90 per share, more than $13 down. The one insurance company that had somewhat weathered the increasing financial storm appeared to be in the same boat of many of its competitors.

It didn’t take long for McKay to figure out what happened.

The winds were fanned by Morgan Stanley investment analyst Nigel Dally, a man who has followed Aflac and the insurance industry for many years. He issued a report raising questions about nearly $8 billion, or about 12 percent, of Aflac’s investment portfolio. The concern centered on hybrid securities, a complex investment in European banks that was under scrutiny.

The wording in Dally’s report was strong and cautionary.

“The hybrid security prices related to these institutions were already under pressure at the end of last year," Dally wrote in a note to clients. “However, those price declines pale in comparison to the sharp fall-offs we have seen in the past week, where the investor concerns over the possibility of nationalization of some institutions has led many of these securities to decline 30 percent or more.”

Dally then cautioned investors to avoid buying Aflac before the release of fourth-quarter earnings on Feb. 2.

That’s Monday. What happens next is anybody’s guess, but Aflac will go on the offensive with analysts and shareholders, defending its investment portfolio. There will be a lot of interest in what Chairman and Chief Executive Officer Dan Amos and other company leaders say.

Amos will talk to analysts in conference calls this afternoon and Tuesday morning. There are face to face meetings scheduled in New York.

There is no doubt the company’s investment portfolio will be a topic of conversation.

Seven Schwartz, a Raymond James & Associates analyst based in Chicago, has been following Aflac for more than two decades, longer than any other analyst currently monitoring the supplemental insurance company.

“There are going to be a lot of issues,” Schwartz said. “The earnings are going to be the earnings. We all expect them to be up and they will do a number somewhere close to it. But that’s meaningless.”

Schwartz explains.

“They’re going to be looking at sales, and don’t think anybody will be surprised by weak U.S. sales due to the recession,” Schwartz said.

Friday, Aflac’s stock closed at $23.21, not far from the closing price the day the stock fell dramatically. But the last six trading days have been anything but steady. Last Monday, the stock lost another 20 percent before rebounding on Tuesday and Wednesday with 13 percent gains each day.

McKay’s phone is not the only one that has been ringing. Other analysts have been issuing reports, some that have upgraded positions on the stock. Aflac Senior Vice President of Investor Relations Ken Janke Jr. has been doing what he can despite the fact Aflac has been in a “quiet period” where executives don’t say much leading up to earnings reports.

Janke broke the silence late last week.

“The note simply spooked the market,” Janke said on Thursday. “And that is probably an understatement on my part.”

Schwartz agreed.

“It started going down before the report,” Schwartz said last week. “It didn’t surprise me the stock went down. That it went down that much, surprised me.”

The Morgan Stanley report was not a downgrade, but it had a similar impact, Schwartz said.

“It was a good report. It was an accurate report. Kudos to Nigel Dally,” Schwartz said. “He saw something no one else saw and put two and two together. Most people thought Aflac’s financial exposure was safe.”

One of the points in the Morgan Stanley report was the European financial institutions such as the Royal Bank of Scotland and Barclays could be taken over by the British Treasury and the hybrid securities might be worthless. To compound the matter, the securities had lost more than 30 percent of their value in the week leading up to the Morgan Stanley statement.

“Nigel accurately pointed out in nationalization, that this was no longer a sure bet,” Schwartz said.

Dally, through an associate, declined on Friday to comment for this story. He was not cleared to speak with the media, the associate said.

Janke contends the investments are safe, but acknowledges the risk.

“More than 70 percent of what we own is senior debt,” Janke said. “That’s our preference. The concerns raised last week are over a lot of things issued by banks, and obviously the banking industry is challenged in the U.S. and around the globe. The question is: If the governments nationalize the banks, are you guys going to get paid?”

That question has generated a lot of discussion.

“The last course of action is for a government to take over a bank,” Janke said. “The government wants to be the business of regulating the banks, and taking them over is not the desired route. That being said, there have been a few cases recently of bank nationalization in Europe - one in Ireland and two in the United Kingdom. In each of those incidents, the types of securities we own have been honored by the government who took over those banks.”

The investments in question have characteristics of debt and securities.

There is no contractual security date, Janke said, but there is an economic maturity.

“There is an expectation the bond will be redeemed,” he said. “It is priced like debt, has interest like debt, the interest is tax deductible and it is rated by agencies such as Standard & Poor’s and Moody’s. But it is not clear-cut debt. But the preponderance is it’s more debt like than security like.”

One of the things McKay, the financial adviser, had to do with his clients was educate them on the securities that came into question. The education was critical on Jan. 22 when the stock was falling at an alarming rate.

“They wanted to know what a hybird was,” McKay said. “What I did that day was a transfer of knowledge and education. I was more of a therapist than an adviser. But I had some calling saying they wanted to buy more.”

That’s generally the case with Aflac. Investors are not used to seeing financial guru Jim Cramer, of Mad Money fame on cable television channel CNBC, talking about the Aflac duck getting “bagged.”

There have not been many situations where the stock got hammered over its investments. Generally, issues with Aflac revolve around policy sales declines in Japan, where the company does 75 percent of its business, and the U.S.

The only recent case of a major investment issue was December 2003 when Aflac got caught in the fraud scandal at Italian milk conglomerate Parmalat.

Aflac quickly identified the issue and sold its Parmalat holdings at $284 million pre-tax loss.

Though that was a much different financial climate and investors were not near as edgy as they are today, the impact on Aflac’s stock was minimal.

As Aflac executives go on the offensive today, Schwartz is not sure what the news will be.

“I know there will be a lot of discussion about the hybird situation and policies revolving around recognizing impairments,” the veteran analyst said. “I don’t know what new information will be available, but maybe we will get some. But I don’t know what it will be.”

So, what advice does Schwartz have for investors, large and small.

“This is a concern that has developed,” Schwartz said. “There is no doubt there is some risk, but we think the price decrease was overdone. ... This is not the price to sell.”

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