Q3 2019 Earnings Call
Good morning, My name is the a and I'll be your conference operator today at this time I would like to welcome everyone to the themes third quarter 2019 earnings conference call and webcast. All participants' lines have been placed in listen only mode to prevent any background noise.
After the speaker's remarks, there will be a question and answer session. If he would like to ask a question at that time. Please press star one on your telephone keypad. If you should eat operator assistance press Star zero.
Thank you I'll now turn the call over to know what gun head of Investor Relations. Please go ahead.
Good morning, and welcome to our third quarter 2019 earnings call. Joining me. This morning, our jumble Arty, Chairman and CEO , Bill Wheeler, President and Marty client, our Chief Financial Officer.
As a reminder, this call may include forward looking statements and projections, which do not guarantee future events or performance, we do not revise or update such statements to reflect new information subsequent events or changes in strategy. Please refer to our most recent quarterly and annual reports and other SEC filings for a discussion of the factors that could cause actual.
Results to differ materially from those expressed or implied.
We'll be discussing certain non-GAAP measures on this call, which we believe are relevant in assessing the financial performance of the business.
Reconciliations of these non-GAAP measures can be found in our earnings presentation and financial supplement which are available at IR data theme Dot Com I will now turn the call over to Jim Bloody.
Thanks, Noah and good morning, everyone.
We are incredibly proud of the strategic progress we've made a theme.
And are encouraged that our solid fundamentals will continue to drive meaningful earnings growth.
Sustainable mid teens or are we.
And attractive book value growth.
We achieved record organic volumes at record average pricing returns in the third quarter.
And while our results were below our expectations we are confident.
And our strategy and underlying earnings power going forward.
This quarter I'm, not going to turn the call over to Marty to provide some additional context around the results.
And I will come back to discuss investment trends and how we're delivering shareholder value.
Marty.
Thanks, Jim Good morning, everybody for the third quarter, we reported GAAP net income of $276 million for $1.50 per diluted share. Our adjusted operating income available to common shareholders for the quarter was 243 million or $1.34 per share.
Notable items totaled 62 million in the quarter, including 48 million from or annual unlocking process, you know the liability costs.
Excluding notable items total adjusted operating income was 305 million or Dollarssixty seven per share.
Retirement services adjusted operating income, excluding notables was 318 million, resulting in adjusted operating our weeks Gooding notables of 16.7% for the segment.
Our consolidated net investment earned rate or near was 4.35% in the third quarter, which moderated from the elevated rate affords 67 in the second quarter, primarily due to normalizing and definitely come from alternatives as we expected.
Within the overall near our fixed income earned rate was impacted by two primary drivers.
First declining interest rates weighing on floating rate investment income, particularly the short end of the curve, which fell approximately 25 to 40 basis points during the third quarter.
Approximately 50 basis points over the past six months.
Second lower than expected prepaid income in or RMBS portfolio, which can fluctuate depending on underlying borrowers borrower behavior importantly, none of the deviation was caused by quite a deterioration.
Rather cashcall or timing expectations.
Sure prepayments in the period served to slow the amount of disco recognized within income pushing more into future quarters and extending the average life of the portfolio.
As we look forward over the near to medium term in fixed income.
Based on our interest rate movements through the end of October .
Expect or near in the fourth quarter to be relatively stable around the third quarter rate within a couple of bases points above or below.
This will provide a baseline heading into next year, which could ultimately be higher or lower depending on a variety of factors, including interest rate movements.
And yields on new purchase assets. In addition, we will continue to adjust crediting rates upon renewal down as appropriate and we would also expect to see a modest decline in or cost of hedging.
For alternatives, while these investments are certainly subject to quarterly variability under curtain certain conditions. We expect baseline annual lies returns of approximately 8% to 9% in the fourth quarter normalizing to approximately 10% heading into next year.
Moving to the cost side of our spread model or total cost of funds for the second quarter was $934 million or 3.18% of average invested assets in retirement services.
This reflects a 23 basis point increase from the prior quarter, primarily driven by unfavorable unlocking and third quarter, resulting from our typical annual review of actuarial assumptions.
Turning to cost of crediting the rate increased four basis points quarter over quarter, driven by business mix from the continued growth within our institutional channel as a percentage of the overall business.
It is important to note the underlying trend toward modestly lower crediting rates in each of our organic channels in this environment.
As a reminder, our institutional child carries a higher crediting rate versus deferred annuities since essentially all the cost related institutional are reflected in the crediting line, while deferred annuities also bear expenses within other liability costs from acquisition cost amortization and rider reserve accretion.
Given this dynamic the quarterly variability in cost of crediting typically trends with the mix and timing of institutional deposits in the period.
In other liability costs the rate increased to 19 basis points quarter over quarter, primarily due to the impact of our annual unlocking process I mentioned previously.
As you know, we strive to keep our assumptions updated inline with the interest rate environment and his experience emerges.
In response to the lower interest rate environment, we prudently adjusted our long term rate assumption, which drove an unfavorable impact that was partially offset by favorable experience in certain legacy blocks of business.
The net effect of these items increased other liability costs by $48 million during third quarter.
Provides long term interest rate assumption now anticipates the tenure treasury.
Tenure, U.S treasury yield to grade up to approximately 2.75% in eight years.
Right well below the levels generally assumed in the life insurance industry.
And consistent with our disciplined approach to underwriting and balance sheet management.
Excluding notable items other liability cost of 292 million or 100 basis points of average invested assets in line with our normal range of expectations.
Moving to operating expenses, we continue to benefit from our highly scalable operating platform for the third quarter operating expense ratio was 27 basis points, a four basis point or 13% decline year over year, which translates to roughly $12 million and savings during the quarter.
Lastly, our tax rate in the quarter was lower as result of the favorable statutory reserve unlocking.
Related to similar actuarial dynamics that impacted our GAAP reporting as well as a more favorable mix of business in the near term, we expect the rate to rise moving to an estimated rate of eight and a half to net and half percent in 2020.
With variability depending on mix of onshore versus offshore income.
Putting this altogether the third quarter net investment spread in retirement services is $330 million or 113 basis points of average invested assets.
Excluding notable items.
The net investment spread and retirement services was 135 basis points.
After reflecting our platform costs, including DNA, which I just discussed that service and taxes.
As well as our corporate segment, our adjusted operating return on assets. Excluding notable items was 103 basis points for the third quarter.
Turning to capital we successfully completed our second preferred stock offering in the quarter raising $345 million of gross proceeds.
With this additional capital offset by capital deployed for organic growth and share repurchases at attractive returns. We ended the quarter with $1.8 billion of excess capital and approximately two and a half billion of uncapped debt capacity.
As a reminder, on October Onest, we closed the sale of 67% of accurate to the either fund.
Resulting in 575 nine of capital being transferred to the theme in exchange for Economics, and 6.6 billion of invested assets.
This is primarily composed of two thirds of the Lincoln block reinsurance deal and the Bristol Myers PRT transaction as previously communicated.
Our capital ratios remained strong at the end of the third quarter with an email read estimated RBC ratio of 420% and you asked estimated RBC ratio of 421%.
Our strong balance sheet should further be supported by nearly $1 billion of additional excess capital expected to be added from the announced strategic transaction with Apollo as well as on demand capital for MACRA, providing us even more flexibility to deploy capital across economic cycles.
In summary, well third quarter results were impacted by the low interest rate environment and certain notable items, we expect or a multiyear double digit earnings growth momentum to continue next year as our business generates significant and profitable growth.
With that I'll turn the call over to bill to provide comments around our liability origination activities.
Thanks, Marty in terms of liability origination.
The third quarter results demonstrated the strength of our multichannel model as we generated record organic deposit of 5.6 billion up 72% year over year.
Well you might be thinking that we lowered the bar on returns to achieve that result in fact, the office, it's true as the blended underwritten return on the third quarter volumes exceeded 20%.
The largest driver of the quarters activity was our pension close that business, where we closed the previously announced deal with Bristol Myers Squibb totaling 2.6 billion of deposits.
So far this year, we have closed on more than 5 billion of PRC transactions at attractive returns, which is nearly twice the volume we closed on an all of 2018.
While the fourth quarter is typically seasonally strong for PRT and we're continuing to be active in bidding for new business. We expect activity will normalize in the near term cutting off a third quarter high.
Lastly on PRT, it's worth noting that we've made early progress in evaluating the business prospects within the UK pension market as a reinsurance partner to domestic insurers.
While it's early days, we anticipate the UK PR key market could very well be an attractive long term growth opportunity for fee.
Our retail channel generated 1.9 billion of deposits during the third quarter.
Activity was relatively consistent with levels, we saw in the prior quarter the impact of pricing measures in response to lower interest rates was felt a new policy applications. While Paul These policies that were already in process ultimately close during the quarter.
Looking ahead to the fourth quarter, we expect retail sales activity to soften overs as a result of the decline in new policy applications. We saw in the back half of the third quarter.
That said despite the challenging environment, we continue to be an industry leader in the fixed indexed annuity market and we expect domain to remain very competitive next year.
One of the ways. We're doing this is by continuing to expand our product distribution footprint.
On our last call I mentioned, our new relationship with PNC Bank that launched in July and we are having ongoing discussions with a couple of other large platforms that we hope will provide new distribution opportunities later this year or early next year.
In our third party flow reinsurance channel, we generated roughly 600 billion of deposits in the third quarter, which moderated from particularly strong quarterly volumes of approximately 1 billion in the first half of the year as expected.
The decline was primarily driven by the adjustment a quota share levels in a declining interest rate environment as we remain disciplined on preserving profitability.
While it's hard to predict the level of industry annuity volumes and quota share levels can fluctuate. We believe our go forward flow reinsurance volumes have the potential to regain momentum.
Lastly, we closed on just over 500 million of funding agreements in the quarter, including one funding agreement back note as well as FHLB business due to favorable returns.
While these deals tend to be more episodic and are subject to the spread environment. We are optimistic on the issuance pipeline.
So in summary, the third quarter demonstrated the strength of our multichannel model, while also maintaining our disciplined underwriting new business at high levels of profitability.
Notably for the first nine months of the year, we have already exceeded our full year toll from 2018, which means 2019 volumes are likely to be substantially higher the strong result for our platform.
In our organic channel, we're seeing numerous opportunities to deploy capital at attractive returns.
And a mixed the macro environment, a theme differentiates itself as a top solutions provider, reflecting the depth of our expertise execution capabilities and solid capital position.
The industry is still going through a significant restructuring companies continue to seek to reduce exposure the complex liabilities.
Noncore businesses.
As a whole businesses in hopes of redeploying capital in a more accretive fashion.
We believe our excess capital serves as a strategic differentiator for a theme and further cements our position.
As the preferred industry consolidator.
Our strategic capital solution Acura.
Will meaningfully supplement our standalone capacity.
As Marty mentioned it became effective on October Onest and today, we have closed on 3 billion of third party commitments for investment into Acura, making solid progress towards the $4 billion targeted amount. We continue to expect that will reach the target sometime around year end.
When combining a theme standalone excess capital in bed capacity.
With a third party capital of MACRA as well as the incremental excess capital will be generated from the strategic transaction with Apollo.
We estimate the total deployable capital could support approximately 90 billion of acquired liabilities.
Now I'd like to turn the call back over to Jim to discuss investment trend capital and our strategic progress.
Yes, Thanks Bill.
While the third quarter results were impacted by the lower interest rate environment and seasonal items from annual rate unlocking.
We saw strong underlying trends in the business.
Including the record organic growth at very attractive returns that bill discussed.
This drove a remarkable 20% year over year growth in our total invested assets.
Which now exceed $120 billion.
In light of the current environment I'd like to remind you of how declining rate impact our investment portfolio.
First 78% of our fixed income portfolio is in stable fixed rate securities.
As rates decline the value of the security increase.
And we generated significant unrealized gain.
Declining rates do not impact the enforce yields of the securities.
Next.
17% of our portfolio is in floating rate securities.
Which were generally bought at a discount to par.
As a reminder, one of the primary ways, we generate alpha in our portfolio is through differentiated asset allocation.
We have these floaters in our portfolio by design, which is mostly comprised of our COO and RMBS assets.
In the case of RMBS, our investment expertise and dynamic asset allocation capabilities.
Allowed us to identify purchase the bulk of the security several years ago at approximately 75 to 85 cents on the dollar.
Which represents a tremendous value and continues to benefit our portfolio today.
To give you a sense of the magnitude are floating rate portfolio has generated more than $800 million.
Or 23% of our investment income year to date.
Through a combination of interest income and accretion.
So overall the earnings from these securities.
All right meaningfully accretive component of our investment spreads.
We invested $7 billion of flows during the quarter and based on our current pipeline. We think we will invest more than $30 billion to the full year a record.
Consistent with our philosophy as active asset managers the yield on our fixed income purchases this quarter.
I was approximately 45 basis points higher net of fees.
Then the Triple B corporate index.
In an environment, where interest rates have grinded lower investment yields are even more challenging to deliver.
Despite these headwinds we are working hard to identify attractive risk return opportunities.
A variety of asset classes.
We are hot we are highly focused on sourcing better yielding non CUSIP investments to generate attractive net investment spreads.
Without assuming disproportionate credit risk.
We are doing this by working with our partners at Apollo.
To build out senior secured direct origination capabilities.
Variety of asset classes that allow us to access a consistent flow of opportunities.
Much more attractive spreads than we can otherwise capture in value start CUSIP based corporate credit.
In aggregate, we expect to invest more than $3.5 billion indirectly originated private credit this year.
Not including our private corporate portfolio.
These assets were sourced across a variety of asset classes, including aircraft leasing private credit.
You asked residential and commercial mortgage loans.
Non U.S. residential loans.
And franchise loan franchisee loans.
As an example of continued progress in improving our sourcing capabilities during the third quarter Athene announced an agreement.
To acquire a large aircraft lease portfolio from PK Air Finance.
A leading aviation lending platform acquired by Apollo from GE capital.
We expect add approximately $1.7 billion of aircraft structured securities when the transaction closes later this year.
And going forward, we expect this platform to provide us more than $1 billion of new investments per year.
Turning to our alternatives portfolio within our retirement services segment, we generated an annualized return of nearly 9% in.
In line with our expectations for the third quarter.
In terms of specific highlights mid cap in Amerihome.
Our two largest alternatives position.
We turned 14.9% and 14.0% respectively.
Strength in both investments was driven by increasing fee income from heavier loan origination volumes.
Elsewhere in the portfolio our investment in sister company store.
A European reinsurer.
Appreciate it as a result of its continued growth in.
Including the pending acquisition of Veeva.
The second largest life insurer in the Netherlands.
Athenes realist real asset investments as well as Catalina.
Runoff PNC reinsure also contributed to the quarters return.
Our alternative strategy remains differentiated in its makeup.
And while his quarterly returns can vary.
It has helped us generate double digit returns historically.
Before I open the call to your questions I wanted to take a step back to highlight the many ways, we are creating long term.
Sustainable shareholder value.
We have been increasingly transparent with all of you in discussing our business trends.
As well as seeking feedback about potential areas, where we can improve.
And we look forward to maintaining and open dialogue.
Ultimately, we believe the primary driver of long term shareholder value is effective capital allocation.
We remain focused on deploying capital into the highest returning areas across organic growth.
Acquisitions share buybacks and strengthening our balance sheet to drive additional ratings upgrades.
Our execution to date demonstrates meaningful progress.
First we have exceeded our growth plans, while achieving attractive mid teens are higher targeted returns across our organic and inorganic channels.
The result is that we've added approximately $50 billion of attractively priced liabilities in less than three years since we went public.
Representing a 70% increase in our total invested assets.
Second we demonstrated the strength of our capital position.
And taking the steps to improve our ratings.
Achieving a ratings across the board from S&P fits in A.M. best.
With expectation is to achieve a plus ratings.
These rating upgrade health, so help us grow more quickly and more profitably as illustrated by a return to the funding is in the back note market this year.
Third.
We've demonstrated our willingness to control the factors we can.
To help close the gap between our exemplary operating performance and our undervalued stock.
Opportunistically repurchasing our shares in size has been a tool in our capital management strategy.
Since late last year.
And we've been very active capturing high teens returns through this deployment.
Our board has provided five authorization increases in less than 12 months totaling $1.6 billion and capacity.
Through October we have repurchased more than $909 of our shares to date.
Amounting to approximately 12% of our current market cap.
Significantly greater pace than most companies.
Finally.
Another key example of our proactive strategy to unlock shareholder value.
Is that transaction, we announced last week to eliminate ethane multi class share structure.
Importantly, this transaction serves to broaden our appeal.
To a range of active and passive investors.
Significantly enhances our index inclusion eligibility.
With a key provider like S&P Dow Jones.
Once the transaction closes, which we expect to happen during the first quarter of next year.
We believe a theme will be fully eligible for inclusion in a major S&P index, such as the S&P 500, or SMP mid cap 400.
While inclusion could take time and is subject to the discretion at the S&P Index Committee.
I mean would otherwise not be considered without taking this important step.
In addition to transaction deepening the strategic and economic alignment of our long term partnership with Apollo.
Offers an attractive financial investment in their business.
And augments Athena capital base for future growth.
We remain confident that the transaction will generate significant value for our shareholders overtime.
And our tremendously excited about our prospects ahead.
With that.
We'll now turn the call back to the operator and open the line for any of your questions.
At this time, if you would like to ask your question. Please press star one on your telephone keypad.
I wish you well move yourself from the Q you may do so like pressing the pound key we remind you to please on the your line will introduce and if possible pick up your handset for optimal sound quality.
First question will come from John Needle would you be please go ahead.
Hey, good morning, I have a question if I adjust.
Your third quarter results for the notable items and they take into account sort of current market conditions.
I know, it's getting late in the year, but do you still expect to exceed $7 per share.
In operating EPS in 2019, and then my follow up to that is.
Marty I think in your prepared remarks, if I heard you correctly.
You indicated that you expect EPS growth to continue to run a double digit pace.
Is that something we should be expecting for 2020.
Hey, John I'll, Oh field, both of those questions.
When we talked about the $7 EPS number that was really before a couple of things one was a quarter here in the third quarter was a significant amount of notable items $62 million after tax including unlocking.
Obviously, which was not in the mix at that time, we did not have any prediction on time and did not after that and then obviously with lower rates since then.
Thats impacted us I think if not for those two things we would have been would have expected to continue be just over seven bucks for those two things together.
Kicked us what will be frankly below seven bucks for the per year. The RMBS stuff I referenced in my remarks is not just the coupon income but also prepayments.
Click on or non agency RMBS slowed down a lot so the.
Accretion of discount slowed down a ton in the third quarter for giving example, it was like $9 million benefited income for the quarter versus a total of about 70 million in the first half of the year. So a big slowdown which is not to say, we're not going to get that income. It's just to say it's been delayed as the businesses but are.
At least at the moment is running off more slowly than we would predicted so talking about 70 million from that in the first half versus $9 million quarter, So very stark.
Decline, which hard to predict when that's going to recover but we do expect to get get that accretion of discount back.
Which is like 400 million over the next to 3.9 or four years of the average life for that portfolio.
On 2000 on 2020, yes, we do expect double digit growth, we'd expect a rebound.
Listen I think the fixed income near.
For 11 as I said in my remarks.
Of the baseline heading into next year, and it's going to then be impacted by.
You know what happens with rates and the new money stuff, it's going be to some extent impacted by do does accretion of discount pickup in RMBS or not.
But I think even assuming that doesn't pick up we'd expect double digit earnings growth and we'd expect a return on assets of anywhere from 110 to 120 basis points.
Got you and just one point of clarification, Marty real quick.
That double digit pace of EPS growth in 2020.
Is it fair for us to assume that that's off of 2019, excluding notable items in threeq.
Yes, I think that's right.
Okay. Thank you.
The next question will come from Andrew Please Berman with credit Suisse. Please go ahead.
Great Good morning.
Turning to the comment that you're generating you generated unlevered returns in excess of 20%.
And I'm, assuming that's on the deals as well.
How are you able to do that and maybe what kind of competition are you facing.
Moving forward and what's the likelihood of continuing to see good volumes.
Well, you know that Youve put your finger right on the issue Andrew its a.
So we.
It's hard in a competitive environment to exceed 20%.
And what we started that this year this quarters because of the low interest rate environment, we tightened pricing a lot.
And.
And honestly looking back we probably over debt.
Now the good news the returns in the quarter, where our great.
But volumes are slowing.
And so we're going to move the pendulum back a little bit and in terms of we've already done that frankly.
In both the reinsurance and the.
And the retail business so.
We're not going to sustain 20% returns we're going to you know and volumes are going to pick a momentum back up but we clearly slowed a little bit the end of third quarter.
So.
That was so that's that's a little color on what happened so it's.
No. It's it tells you know the margins that are out there I mean, our 20% margins you know, we obviously have certain competitive advantage that almost nobody else enjoys.
And that allows us to earn superior returns and still be competitive but.
I do think we maybe over dipped a little bit in the third quarter Hey, Andrew. This is Jim I'd, just add to that our target returns for organic business remains mid teens. So we're not changing that we did better than that in the third quarter.
Got it and with regard to this 62 million of notable items and retirement services.
Could you talk about.
Where your discount rate is right now and.
How much it was slower to him.
Sure.
As I mentioned in my remarks, we moved it down noticed in the low that you did our assumption for the 10 year Treasury.
Eight years out was in the low threes and we've now in this unlocking moved it down to 2.75%, which is a whole lot lower than it is a think elsewhere in the industry.
As a reminder theme started out after the crisis through all the business Weve underwritten in originated since then was in the low rate environment.
So we never really had liabilities on it at high rates, but we've also tried to be very prudent and take that rate down. It's very important us to have a very prudent balance sheet that well capitalized with no legacy liability risks and very well underwritten liabilities and part of it is putting those liabilities on our books that what we think are.
Are pretty reasonable assumptions and so 2.75 treasury in this environment.
It was like.
Let's just about right number for a longer term view.
That sounds right and just in terms of the funding for ACRA. You're are you are you close to getting the $4 billion of capital commitment.
Yes, we are.
Fares I.
I think.
The other one large investor that's just about ready to sign we're just we're dragging them across the line.
We're chasing the last five of them.
Awesome. Thank you.
The next question will come from Tom Gallagher with Evercore ISI. Please go ahead.
Morning, first Marty just a follow up on.
The near expectation you you said you thought it would be stable on for Q is that do you have visibility that you have lowered crediting rates enough to offset the negative impacts that you expect from floating rate.
And and for Q or is that because you're expecting some of this RMBS.
A prepayment negative two to reverse itself.
I really I think that.
My commentary was really on the fixed income years, that's been about the same and we're not really calling for a big rebound in that in this next quarter I think there'll be some of it because its unusually low maybe for a variety of factors, but my commentary was really reflecting not really any kind of will come back in that.
Yeah, I would expect fourth quarter.
The return on assets to be kind of in the ballpark, where it was this quarter.
Excluding the notables.
On the constant crediting I think it's important to remember that well.
When interest rates, particularly LIBOR moves down.
Floaters moved down very quickly one and three month LIBOR is great preponderance of our from our portfolio but.
On the crediting rate side.
Is as big of a lag effect right, we Kansas take all the in force down right away and I think what you will we'd expect in this current environment Tom is that in over the next.
Few quarters heading through next year. The overall crew rate is probably going to drop a couple of basis points are so a quarter what could be one or two basis points, two or three depending on the quarter, but little slowly ticked down as we do take the opportunity as business comes up for renewal to reset it at lower rates.
And then also in this environment expect a little bit lower cost of hedging.
It's interesting in the deferred annuity book.
For the legacy business, the cost of creating actually in deferred annuities did tick down two basis points.
The third quarter. It was offset by two basis points of increase from new business. We put on quickly MYGA business in the second quarter MYGA is almost all lot of that returns and credit in the rate Theres not really any writer reserves on it obviously and so the decline in the in force of a couple of Beeps was offset by a couple of beeps on new business in the.
Second quarter when rates are higher.
But we wouldn't expect that dynamic to continue just expect in a couple of beeps or so decline over the next few quarters. So it's sort of a lag effect on the crediting rate side.
Just a follow up on that do you have more flexibility to lower crediting rates its.
South sounds like pretty marginal marginal impacts here and.
Obviously this is a.
There's been a decent near term negative earnings impact here, just curious why why you wouldn't be taken more aggressive actions on crediting rate side.
Well, it's it's not like it.
Really bad quarter or without.
Without doing that I mean, I think we're trying to be prudent and manage our business well for the longer terms the business that we've sold in the last two to three years.
First of all some of Thats been product it doesn't really have the opportunity to renew because it has multiyear guarantees maybe three years of for something like that you can't renewal, but stuff, we just sold a year or two ago.
We don't try to ratchet those rates down a whole lot we want the business to sit there would be relatively stable, but we do take the opportunity in an older stuff and you know we're getting some decent margins I think if not for the notables this quarter and the slowdown in RMBS prepayments was not a bad quarter. None of that is not a great quarter, certainly but not something.
That we'd want to hurt or long term reputation in the marketplace.
Tom.
Yes, we do have the ability to roll rate faster.
And.
We choose not to main as Marty talked about because what we if you go really fast acting out what might be perceived as a compressed as way.
You know the market will the market will punishing.
Right and we've seen that with other carriers who have.
For whatever reason tried to move rates down one or two years after selling the business and you know producers or don't like it so where it's a judgment call and all in terms of how how fast we adjust them. It is fair to say right sort of what we are quite a bit lower.
And our feeling sort of is is if they get.
Ill meaningfully lower.
And we'll probably have to start acting more aggressively.
But you know I think we're so we're trying to strike a balance Tom. This is Jim one more thing grew with everything fell Marty said.
But essentially 112 of our book, we have the opportunity to reprice every month ballpark generalization et cetera.
And you're right, we do have a.
Fair amount of.
Lee way until we would hit minimum so.
We're going to look at that very carefully and.
As opposed to strike the right balance but.
That's a subject of Oh.
A lot of discussion here, especially as we head into 2020 and.
Keep in mind, our profitability everyday on that so.
Well communicate more as we go along but we do have flexibility to take those down and we're going to look at it carefully.
One last point and it's a mentioned in her remarks, but just the don't lose sight of that type of is that.
We are writing more institutional business and that does that higher crediting rates because with many of the liability costs. So to the extent that mix increases. The overall crediting rate may not shrinks you have to look at the underlying trends and businesses, the PRT and refund agreement rates declines in institutional quarter over quarter.
But obviously the mix of that business was higher so we saw the overall crude rate increase but the underlying trends and all the organic channels around the way down.
Okay. Thanks.
The next question is from Ryan Krueger with KBW. Please go ahead.
Hi, Thanks, Good morning, I had a question on the fixed income yield.
For the for 11, good run rate ending the year going into 2020, it's just in light of the current interest rate environment and assuming no no changes to the interest rate environment can you give us some sense of.
The trajectory that that may have in 2020, I mean, when we would you expect some some further declines based on where we are investing new money.
You know and the current environment right and there is the moving parts, it's very hard to predict exactly I'd expected to be around the same ballpark give or take a couple of basis points RMBS speeds are one factor.
How we invest in what goes off the books is another but that's kind of I think a decent baseline in the current environment, Hey, Ryan one of the things, we're counting on and I mentioned in my.
Script that weve.
Having a lot of success in sourcing non CUSIP assets.
$3.5 billion the way we define it this year, we would expect it to be more next year.
Those assets without sacrificing credit quality.
Our higher yielding and we're looking for.
Those type of assets to become a bigger part of our portfolio.
And we'll either increase yields or at least offset any other declines from our floater portfolio.
But.
Biggest on affording portfolio, our two biggest components are close and.
And RMBS.
And so those are actually high quality CLL as the most part.
A bigger portfolio in RMBS and I think they performed very well we expect in the performed very well next year as well, but but the non CUSIP origination is a key part of our strategy to offset any declines in yields.
Thanks, and then.
In regards to inorganic opportunities.
Do you think.
Counterparties would be potentially willing to transact in the current interest rate environment or is that do you view that as a meaningful headwind to getting deals done.
Well it clearly is.
As a negative influence, but I don't think it stops people from transacting I.
A lot about has to do with your attitudes about where you think of districts are going and get on what's the psychology around that and.
I think people, who really feel they want to transact for strategic reasons, they want to exit a block for something like that.
Our free up capital.
You know it all depends about the I think it's going to get better on a year or not and I would say the reality is as most people probably don't think interest rates are going to get a lot better in the next year and so and so.
In our discussions with various management teams.
They still seem very interested in transacting.
And you know and and I.
There are obviously want to see where pricing comes out, but there, but I would say, it's an impediment, but not.
Maybe not a major one.
Thank you.
The next question is from Erik bass with Autonomous Research. Please go ahead.
Hi, Thank you can you talk about the sales environment in retail and whether competitors have been responding rationally to the decline in interest rates in terms of their price adjustments and also have you seen any change in consumer appetite for annuities.
So.
There's two parts to that question one is in the and the MYGA market people clearly have pulled back.
And MYGA sales CNO traditional fixed annuity sales are seem to be off quite a bit.
And I am interested obviously the base interest rates are much lower.
And so.
So I think competitors have reprice, some but they're probably not as much as they shut up.
So.
So that's that's kind of what I would say with regard to indexed annuities.
It's not clear how much indexed annuities have slowed.
Hi, I don't have a great feel for that at the moment Bill I see the third quarter numbers.
Interesting for us is.
Our into next to indexed annuity sales are going to be up year over year.
It's still a.
It's a product class which is.
Got a lot of secular growth.
Never mind whats going on with interest rates. So at a so I would expect it to grow but maybe maybe the growth rate will slow.
Competitors to they may be made.
They have repriced, a little probably not as much as they shut of.
And so so I think that's kind of.
What's going on in the market.
Thank you that's helpful. And then your comments on PRT and interest in the European market would that be is a reinsurance counterparty or would you be able to directly sourced deals and do fully funded deals in Europe .
No we need to be a we aren't licensed on the ground. There. So we have factors are reinsurer.
And I picked up that way.
I think strategically we've kind of concluded that the right way to go.
Got it so would you just be taking the longevity risk or would you be able to get assets as well.
No no assets as well, we're not we're not interested and just isolating logs out here that felt like others, where we're interested in the whole.
Taking a percentage of the whole liability.
Got it thank you.
The next question will come from Humphrey Lee with Dowling and partners. Please go ahead.
Good morning, and think of taking my questions just related to the assumption review should we expect any impact on auto liability costs going forward.
Hey, Humphrey, it's Marty no I would expect them to try to be in that bounce around between 95, 9700 hundred two basis points quarter to quarter.
We feel like taken our long term.
Interest rate assumptions to 75 from low threes that should hold is for a for quite some time, it's a very prudent number we think and we think we took an another we've been updating our actuarial assumptions every quarter as we see experience and looking forward that ended up being a slate good guy.
This quarter, but no I don't expect to material difference in the other liability cost rate from what had been.
Got it and then just to follow up on the cost of funds in general thinking your earlier in response to your question you expect the cause of crediting could see maybe a couple of points sorry, a couple of basis point decline in the future quarters as you kind of reprice. Some of the book and then but then in general should we expect.
Cost of funds to be kind of remain at kind of close to 3% level going forward all given the mix shifts or is there any any any trajectory that could kind of more kind of coming back down to like to a two to seven to eight ish.
Yeah, I would say that again, it's kind of very much depend on business mix, but.
As we kind of look forward on business mix and again, we pivot across our channels, where we see those opportunities that could certainly move around.
But I think that the liability costs is assumed to be kind of normalized level as spoke about a minute ago.
And I think will reprice them deferred sooner in the institutional will drop in rate just given the low rate environment stays there. So we'd expect a couple of deep in aggregate roughly quarter by quarter across the whole liability book.
Again, I would urge you and others to kind of look more deeper within that looking for an annuity business and institutional business, but in aggregate with a business mix we'd anticipate.
We'd expect the overall costs occurring to slow down a basis point or two maybe three to putting in the quarter over the next four or five quarters.
Got it thank you.
The next question is from Alex Scott with Goldman Sachs. Please go ahead.
Hi.
Thanks for taking the question. So the first one I had was sort of back on the on the pipeline and I know, there's a lot of focus on interest rates and with that may be doing to the pipeline could you talk about like your ability to source assets and how that may be impacting your your pipeline on why you're willing to do I mean, it sounds like more direct.
Dr. As a nation, you're you're doing that I think that probably helps a lot with.
Supporting the retail flows, but do you have enough direct origination opportunities to still go out and do big deal us and be able to generate the kind of alpha that you want to be able to in the current credit environment.
Yes, Hi, Alex.
The answer is absolutely.
Talked about what we've done so far in a.
Quote senior secure directly originated credit this year it would be more next year.
We have an ongoing allocation to that asset class and our weekly net investment earned rates that we provided to our liability pricing people.
So that we're in sync on that.
That shows our confidence that that we're going to continue this momentum I mean.
Apollo and we are in contact with a lot of different counterparties, they want to do business with.
Counterparties that have a lot of capital.
And Counterparties that you wouldn't even think we'd be dealing with that want to partner on various origination platforms initiatives et cetera.
Silicone valley or across the board so.
A lot of conversations PK is the best example, so far but we expect more to come in this arena and you're right that drives our earned rate and our ability to be competitive and all aspects of our liability platform.
Alex I'd say, one other thing we're very careful to make sure.
You know as asset allocation does on.
You know very significantly between different channels in markets and product categories right it'll vary a little bit just because the liabilities are a little different but there are but you know if you give the juicy assets to one particular market or product.
You are effectively subsidizing.
You know that channel and versus others. So were we try to be very careful about how we.
Manage.
Manage assets.
Folio target no that's right like we're very disciplined on this and unless we're confident that this percentage of every asset allocation.
Sorry.
It's sustainable we don't put it in there it's not likely change this allocation every week. So we're confident enough very confident in this.
Directly originated category private credit.
That we havent allocation, there and we expected to be in there.
Permanently.
Got it thanks that's helpful.
Follow I had is on the lifetime income benefit reserves.
And just thinking through the review that you did and bringing down the ultimate assumed interest rates I mean should I expect any difference in the way that those liabilities are accruing will that affect your go forward earnings power I think it's sort of works as a key factor the way that that accrues, so well that K factor is sort of increase.
This is I guess the question.
Yes, I think it'll increase very modestly Marty, but I don't know again, I think that of the liability costs.
Overall rate, we talked about which includes amortization ADAC as well as write a reserve accretion.
A couple of things I think that's going to probably be anywhere from 95 to 105, the kind of hover around 100, maybe just under 100 basis points in aggregate, including that.
Got it thanks.
The next question is from John Barnidge with Sandler O'neil. Please go ahead.
Thanks, the withdrawal rate as a percent of beginning period assets was the lowest in a year, how should we be thinking in that going for police.
Yeah. It is a bit lower which is which is a good thing.
You know, we're still looking at how to do the financial plan for next year I would still think at this point we'd expect to.
Decrement rate in aggregate around 10% give or take will fine tune that a bit as we go here.
And it's been higher the last year to then.
Then it had been before and we expect the year to come back down but.
I think it's impacted by a couple of things. This year. One is the older Veeva business did a lot of business nine and 10 years out and so that business is coming up out of its runner charge period, but then.
Seven.
There is out and so far they didn't do that much as being kind of a lump of stuff coming from new Veeva stuff.
So that raises the decrement and then with the addition last year of.
The voice transaction in Lincoln transaction, which grew older more seasoned blacks.
Those also overall served increased the decrement rate, which again is priced into the business as we looked at those blocks.
Those blocks are more seasoned, but also more stuff covenants running charge, so there's probably a little bit more variability quarter to quarter with those but I would think that for the near term.
Looking at roughly 10% detriment rate it could be a point above or below that is probably about right.
Okay. Thanks, So my follow up giving you get increasing scale.
Being achieved how should we be thinking about operating expenses as a percent of total assets. We didnt seem reasonable that have made ticked down to a basis point or two each year.
Yes, it could obviously, it's a function of how much we grow on them and when we do inorganic stuff the kind of.
Jumpstarts, our growth even more because we're growing pretty decently organically, but obviously when you do organic stuff inorganic deals, which is our strategy goes up a lot.
It could go down a basis point per so next year, just organic growth will have to see I think also I would note that.
There's a lot of GAAP accounting changes happening diesel, which we've basically you're done with what we're still putting in place and then LD tea, which is a massive undertaking those are the things that yes, we and others industry have to do and there's a lot of money we have to spend on changes to our processes working with advisors lot of IP changes.
That kind of elevated on a onetime basis. So I would think and hope we could go down certainly longer term, but next year, it's certainly going to be impacted by a couple lose gap things. So the decline may not be as much in terms of business points and it could be just relatively stable to the nickel to grow could come down to be we just something inorganically should come down a lot.
The next question is from at least Greenspan with Wells Fargo. Please go ahead.
Hi, Thanks. Good morning. My first question on now that you guys are close to fund raising for act.
I just trying to get a sense of on how you guys have you spoken with investors about putting that capital to use.
Now you have the legacy CMBS, so the on Bristol and Lincoln going in there, but how do we just think about on additional deals and pipelines and what time frame. If you communicated to invest curious putting that capital use and it has there been any change over the past your model.
At least felt no there hasn't been a change in our AR.
We have a four year window from you know the initial closing two.
To invest that money and so.
And thats consistent right. So at a we haven't given that many new messaging about all looks like going to be later or looks like it will be faster.
In all our expectation is that will be pretty active and.
So I wouldn't say our outlook there has really changed.
Okay, and then in terms of.
Modeling as we think about on the PK tariff Air Finance assets.
How should we think about.
Current that you expect on those assets can you give us on some kind of guidance there.
Yes, I won't be specific a lease but.
I think what you'll see and this.
Could the way you see in future of these types of transactions is.
Essentially there'll be a securitization where.
Most all of what we're getting is going to be investment grade rated most likely asset backed securities. That's the case here in this PK finance.
And now yields on those will be.
I significantly wider than what we could do in the investment way corporate space, even wider than what we can do and.
Other more generic asset backed securities.
And then there is a piece that there will be the equity piece that will be an alternative on our books that'll be in the range of what our normal alternative criteria is.
And I think for alternatives going forward, you'll see more of that business, which we view as strategic alternatives that.
That's a key component in this structure in order to for us to get in this case.
Cost of doing that have dollars of attractively priced asset backed investment grade rated so.
That's the way that may be as small another sliver and another section et cetera, but more or less in material to the total transaction, but.
Thats the way, we view it on a relative value basis, and a sizing basis, and I think thats the model going forward.
Ladies and gentlemen, it in the interest of time, we have time for one final question that question will come from Jimmy Beulah with JP Morgan. Please go ahead.
Jimmy are you there.
Not a muted area.
Give me your line is open.
Jimmy went to the next called in.
Okay.
The next question is from Sunny came in with Citi.
Thanks.
Two quick ones first on the ROI on a consolidated basis.
Or maybe just retirement services, Marty I think you'd said 110 to 120 for the fourth quarter, but did you give a sense of how you expect that to.
Trend in 2020.
Actually I'm glad you asked so maybe on the spokesman ER, maybe miss heard or maybe both but no I think the 110 to 100 Twentys to need is for 2020 kind of overall expectation for next year.
I do think that for the fourth quarter as we mentioned that we think also be in that eight or 9% range.
And I, we don't expect any real recovery in fixed income near so I think with those dynamics.
And we'll have return on assets, that's a little over 100 basis points as best we can predict.
Pretty close to where it was excluding notables this quarter.
We'll have more opportunity to take down credited rates over the course the next year.
And some other things that's why I think we'll get improvement next year, but not in the fourth quarter I'm not going expect that kinda number it's going to be.
Probably around 100 of just over 100 like it was during the third quarter X notables.
Okay, I might or might that them wrong, so apologies and.
And then separately I just wanted to go back to one question from last week's transaction and I ask that last week, but I, just maybe a follow it up but as we think about the consideration mix that you got as part of that deal. It seems very heavily weighted in favour of Apollo stock and obviously, we talked about last week that being somewhat capital in efficient.
From your perspective, but just.
Why such a heavy tilt towards Apollo stoplight, why not more of a blend of cash and shot.
Well.
I mean, it's Marty Atlas's negotiated deal I think part of it was definitely it obviously was driven.
Really by a theme going into a single class that stock and how can we invested fee that was our partner Apollo, but we also wanting to increase alignment certainly with Apollo going to 35%, we're able to not only get rid of dual class that creates more alignment, but also as part of the increasing alignment we thought it would we all thought it would be going for thing to own some.
Carlos.
You know the way that came down though ultimately was to get funded and were Apollo was with its ability to fund the balance sheet and kind of where we were the mix. We took down was or are going to take down I should say is at 350 cash that is going into of Apollo shares. It is capital efficient in some ways, obviously, the fastest cash and thats.
Very capital efficient.
But we still think that.
Should be a good returning asset it's good to increased alignment and so given that was where we were able to get to will oppose the time given what they had in cash and other things. We thought that was a result police Atlantic is much better longer term objective. It's in a couple of things.
Yes upon will have a balance sheet light approach in general so they know they don't fun, many things with cash and so this is the way that made sense for them.
We think this it's a terrific transaction.
Stocks have performed very well since that.
It's a consistent with the.
Stronger alignment that we attempt to have with Apollo.
But you know look the overriding single goal when we entered into discussions about this was.
Both companies need to benefit not going to be a winner and a loser. We think we accomplish that not perfect for either side, but it's good enough and the markets reacting to that I'd bank and.
So.
Yeah, I hear you and while it's the our investment in at the end Apollo stock is.
Like anything else going to be viewed as an all with all capital charges.
But what their dividend yield of 6% and so far so good on the appreciation, we'll see it will be more volatility no doubt about it that's the price we're paying.
For the strategic alliances and getting out of the dual class a shares.
At this time I would like to turn the conference back over to Noah Gunn for any closing comments.
Thanks, operator, and thanks, everyone for joining us. This morning, if you have any follow up questions regarding our results or anything to Scott discussed on todays call. Please reach out to me or Soo Lee and we look forward to speaking with you again next quarter.
Thank you.
This does conclude todays has seen holdings third quarter 2019 earnings conference call and webcast. Please disconnect. Your lines at this time and have a wonderful day.
Yes.