Q2 2020 American Equity Investment Life Holding Co Earnings Call
Welcome to American equity indefinite life, holding company's second quarter 2020 conference call at this time for opening remarks, and introductions I would like to turn the call over to Julio solid coordinator of Investor Relations.
Good morning, and welcome to American equity investment life, holding companies conference calls to tough second quarter 2020 earnings.
Earnings release, and financial supplement can be found on our website at www Dot American dashed equity dotcom.
Non-GAAP financial measures discussed on today's call and reconciliations of non-GAAP financial measures to the most comparable GAAP measures can be found in those documents.
Turning on today's call or not Bala Chief Executive Officer at Johnson, Chief Financial Officer, and Jeff Lorenzen, Chief Investment Officer.
During his portion of the call, Jeff Lorenz Inmobi, referring to the financial and business fact overview slide deck.
Liberal on our Investor Relations website at Www Dot American gosh equity dotcom.
Some of the comments made during this call may contain forward looking statements within the meaning of the private Securities Litigation Reform Act.
There are a number of risk and uncertainties that could cause actual results to differ materially from those expressed or implied.
Factors that could cause actual results to differ materially are discussed in detail in our most recent filings with the FCC.
An audio replay will be made available on our website. Shortly after todays call is now my pleasure to introduce not Bala.
Thank you Julie good morning, everyone and thank you for joining us this morning.
Why booked a human cost of the koby 19, pandemic and the associated broader macroeconomic environment remain uncertain.
American equity remain focused on its purpose of converting retail klein feeding into the bigger different Beatrix Tonight.
Providing secure on retirement income and principal protected accumulation.
We do this with general account annuity products and we bring to market through intermediaries.
Cross channel.
Historically dominant position in the independent agent channel and superior service at the lowest operating cost structure in our industry.
[laughter] by Endemics induced uncertainties of Twentytwenty make this a reset your for most industries.
At American equity, we have been focused on protecting a ways of working stopping without even low even distribution partners and then our balance sheet.
A couple more than that in a minute, but its strong defense will enable that renewed vigor in plain often in the marketplace.
Therefore, we are also using this time to reboot, our business strategy for execution over the coming yet.
To play a strong defense in the second quarter, we bolstered our balance sheet by raising an additional $300 million in preferred equity.
This provides us a strong capital cushion to weather turbulence from briefings migrations and I investment portfolio.
Jeff was doctrine this in a bit later.
But I want to know that readings migrations and credit losses were well within decide to meet days, we laid out on a fourth quarter corn negatively affecting our risk based capital ratio by nine point when taken together.
Yes, they did risk based capital ratio at American equity life as of June Turkey.
Was 389% compared to 396% on my last earnings call.
Why he's got any held at the holding company net proceeds from the 300 million Reais provide an additional 27 points available capital cushion if deemed as necessary in the future.
In essence, we have available capital on the balance sheet that would indicate that we had operating at well north of 400% RBC to weather ratings migration and credit losses through a beat it Oh extended economic uncertainty.
With no debt maturity to 2027, we had operating from a position of strength when it comes to dealing with a multi quarter on must be your economic recession from the current fine dining.
Having no being in the C. You'll see for five months I can share that our strategic vision extends over multiple horizons.
The first few years of this strategy of all work done any calling horizon, one during which we would transform into the next chapter of American equity, Doug as he and 2.0.
In horizon one.
Singular focus is on dominating the V. did annuity business through distribution partners in the independent agent and financial institution channels.
While building new capabilities that modernized how do we do that and how we capture a greater share of the economics in both distribution and asset management value chain.
At the end of the D., we out in the business of raising assets from policyholders at a certain cost of fun and reinvest those on a spread net off the cost of risk appetite.
Therefore, we want to be in adult hofh of the industry peers or even in the fourth quarter idling some capabilities when it comes to raising fun and then investing those funds.
Our plans over the coming good I'll focused on execution around these 280 is why did we need to learn more nice how we go to market.
Looking at things for the quarter gross sales of 559 million back 21% compared to the first quarter Twentytwenty driven by declines in seemed at American equity life in Eagle life.
18% in 34% respectively.
Given the limitations that covert 19 pandemic is based on face to face meeting and the need for social distancing sales pipelines for us and for the industry has slowed down.
In the second quarter bending average 1200, and 43 apps at American equity life and currently stands at Dan 60.
Hi, Sparkle for accumulation product refresh in June we introduced a destinations nine and Stan fixed indexed annuity, which includes the definition index, we called well up and go branded with Bank of America.
This is a rules based multi asset sector index strategy that combined three well established transparent assets.
No wonder duty S&P 500 equities.
And your U.S. Treasury bond and Gord, using two time bested investment principles of risk parity and momentum.
Given our garden participation rates for both the one into your strategy destinations nine and then illustrate very well.
During the quarter, we move.
Almost entirely doing noisy wholesaler modeling Eagle life for both the bank and broker dealer channel.
Why hook bought the wholesalers were helpful to get a stocking in the financial institution speed.
We needed to make the strongest shouldn't do being charger fall one destiny.
Drive greater alignment with a hole in sealing resources and to scale up in focus to account for Eagle lifes product line.
In part, reflecting this transitional Peter that Eagle life vending averaged 93 apps and currently stands at 53.
With some new valentines meat and more expected over the coming few months, we expect meaningful sales go that Eagle life, the stocking 2021.
In terms of access to shelf space. We recently added N P M financial and have been approved that truest Bang for both the form a baby in tea and Suntrust distribution system.
The key for Eagle life is the disciplined execution off our refreshed product and see a strategy first at existing from.
And then by signing up more focused phones overtime.
Turning to financial results for the second quarter of Twentytwenty, We reported non-GAAP operating earnings available to common shareholders of $93 million.
Well, one going up one cents per share compared to $100 million or $1.90 cents per share for the second quarter of 29 team.
Results for the second quarter of 2020 by impacted by lower investment spread and an increase in accretion up the liability for lifetime income benefit guaranteed.
Now I would like to turn the call or what you're dead for additional comments in second quarter financial results.
Thank you why not.
Yeah, one discrete item this quarter, we recognized a 10 million or seven cents per share mark to market loss on investment partnerships that flowed through investment income and operating earnings per share.
The average yield on invested assets was 4.12% in the second quarter of 2020 compared to 4.36% in the first quarter.
The decrease was primarily attributable to about three basis point reduction and the benefit from bond prepayment income.
Seven basis point reduction from investment partnership Mark to market.
Six basis point decline from the decrease in yield on floating rate investments and a six basis point reduction from interest for gone due to the buildup of cash.
The aggregate cost of money for annuity liabilities was 173 basis points up one basis point from the first quarter of 2020.
The cost of money in the second quarter was negatively affected by one basis point of hedging loss driven by minimal over hedging gains and the two basis point cost of an index credit macro hedge compared to five basis points of gain from the over hedging of index linked credits in the first.
Quarter.
Excluding hedging losses and gains the decline in the adjusted cost of money reflects a year over year decreasing option costs due to our active renewal rate management.
Investment spread for the second quarter was 239 basis points.
Trendable spread which we define as excluding the impact of additional prepayment income the effective hedging gains and losses and other non trendable investment income items was 245 basis points in the second quarter compared to 253 basis points in the first quarter.
In our analysis of Trendable spread this quarter, we have excluded the reduction in effective yield of eight basis point, resulting from the mark to market investment partnership losses.
The average yield on investments acquired in the quarter was 4.58% growth a fees compared to 3.49% in the first quarter every year.
We purchase 93 million a fixed income securities at a rate of 3.74%.
Originated a 193 million a commercial mortgage loans at a rate of 3.91% and purchased 154 million of residential mortgage loans at 5.92% grocer fees.
Option costs were basically flat sequentially for the second quarter at 154 basis points at American equity life, only and a 162 basis points for American equity life and Eagle life combined.
Reflecting the decline in equity market volatility and actions we took in June to reduce participation rate on 4.3 billion of policyholder funds and S&P 500 annual point to point and monthly average strategies.
Cost of options at American equity life has dropped from a high of 173 basis points for the hedge weekend at March 24 to a current level of 136 basis point.
Over the same time period, the cost of options for American equity life, and Eagle life combined fell from 190 basis points to 140 basis points.
So the yields available to us decrease or the cost of money right. We continued to have flexibility to produce our rates if necessary and could decrease our cost them money by roughly 65 basis points, if we reduce car rates the guaranteed minimums.
This is oh from the 63 basis points, we cited on her first quarter call.
The liability for lifetime income benefit riders increased 95 million 26 million above the first quarter level.
Relative to the first quarter reserve accretion was negatively affected by the relatively low level of index credits.
Renewal rate management activity and somewhat higher lifetime income benefit rider utilization, reflecting the original quarterly sales patterns and certain cohort.
For the third quarter, assuming current equity market levels, we expect an increase and the liability for lifetime income benefit riders and the 80 to 100 million range.
Deferred acquisition costs and deferred sales inducement amortization decreased by 9 million sequentially, reflecting the decrease in adjusted gross profit and the renewal rate management activity and lifetime income benefit rider utilization cited above offset impart by the effect of the.
A low level of index credits.
The third quarter, assuming current equity market levels, we expect combined deferred acquisition cost and deferred sales inducement amortization in the range of 90 million to 110 billion.
Operating expenses declined from the first quarter by 1.7 million.
Primarily reflecting lower sales promotion activity.
Now I'll turn the call over to John just to discuss our investment portfolios.
Thank you Ted good morning, everybody I'll be referencing pages 31 through 36, or the financial and business facts overview slide deck available on our Investor Relations website at Www Dot American Dash equity Dot com.
Generally speaking we were happy with investment portfolio performance during the quarter, which was well within expected tolerances.
Before starting my overview of the investment portfolio I'll comment on the 27.6 million of credit losses in the quarter and the 10 million dollar mark to market loss from investment partnerships, roughly 18.3 million of credit losses came from write downs of domestic oil drillers. The remaining 9.3 million reflected a smattering of write downs pro.
Merrily on RMBS and CMBS.
Mark to market investment partnership losses came from partnership investments in energy railcar aircraft and hotels current value of our investment partnership holdings is $82 million.
Turning to page 31 of the slide deck, the overall investment portfolio remains and resilient position.
Our net unrealized gain on the investment pork investment portfolio increased from 500 million at the end of March to 3.8 billion at the end of June, reflecting tighter investment spreads and lower risk free rates.
We saw a small decrease from the percentage of our fixed maturity portfolio rated investment grade, but 97% of the fixed maturities are still rate at any IC, one and two well within acceptable range.
On page 32, we highlight our corporate bond portfolio is an excellent credit quality with 96% rated investment grade and it's broadly diversified across credit sectors holdings in what we identify specifically as co bid 19 exposed on our first quarter call are quite manageable.
Roughly 1.1 billion of the corporate portfolio was downgraded during the quarter at least one any IC level more than half those downgrades were from any I see one to any IC too.
On our first quarter call, we highlighted our oil sector holdings overall, we have 2.6 billion of investments in the energy sector was 68% of our holdings midstream integrated in refining not at significant risk.
We have 55 million of investments in oil drillers have which offshore drillers have a total value of 8.2 million. We have written down our offshore names to 11 cents on a dollar.
Our retail portfolio, which totaled 784 million at the end of June was stable with 29 million of investments downgraded from any IC three to any IC for.
Turning to page 33, our COO portfolio is performing as expected during a time of stress approximately 69 million of our holdings were downgraded one any I see level during the quarter all from any I see two to any I see three.
Across our COO portfolio that percentage of underlying loans are rated triple C. By standard and Poor's has grown from 3.6% as of March 30, Onest, 10.22% as of June Thirtyth. While this level is elevated it is in line with the general market.
That said see allows have a self killing mechanism once triple sees exceed a test threshold normally around 7.5% Overcollateralization test triggers occur in cash flows diverted from the equity tranche to pay down the senior most troche, which ultimately strengthens the COO.
On page 34, we provide an overview of our CMBS portfolio.
The portfolio held steady in the quarter, what the ratings disturbing distribution basically unchanged, we had 115 million of downgrade of one any IC level or more.
Most from any IC, one to any IC too.
As a reminder, 23% of the portfolio was within single asset single borrower or essay SB transactions. All the portfolio was purchased after the great financial crisis, we significantly and we significantly Curt curtailed new purchases since 2016.
[noise] retail is 35% of the portfolio or 1.8 billion in mall exposure is 727 million or approximately 41% of retail.
At least 60% of the mall exposure is within essay us be transactions and high quality names that we continue to feel good about.
Looking at the performance of the underlying loans, 9% aren't special servicing status, 11% of underlying underlying loans have been modified usually allowing forbearance for three months with missed payments to be paid back over the next 12 months. There is some overlap between the two categories. So it's not one to one.
Turning to page 35, our commercial mortgage loan portfolio has performed quite well see I'm. One loans are as a percentage of total dropped by two points to 79% in the quarter, but the entire portfolio remained cm one or she MTO.
Through the end of June all payments, where current except one loan we had told a request for relief on about 215 loans of those we provided various types of payment relief on a total of eight loans with an unpaid balances just 28 million for a total of deferred principal payments of $278000.
Finally, just to put things in context on page 36, we show the estimated capital sensitivity to a 12 to 18 month economic recession, consistent with Federal reserve seat CCAR stress test that we presented on our first quarter call.
This scenario is in line with and maybe a little even worse than actual experienced during the great financial crisis.
What we found is an expected decrease of roughly 75 risk based capital points, mostly stemming from the increase in required capital needed to support ratings migration.
To date, we've just seen eight points of risk based capital decreased due to ratings migration and one point from credit.
As a reminder of the total expected decline in RBC from the March 31 2020 level.
Would occur over 12 to 18 month period did not assume statutory operating earnings any capital contributions or any mitigating management actions. We are of course actively engaged to minimize this impact.
To sum up this is just a first full quarter of economic life with a pandemic, but we feel really good about our portfolio performance and positioning.
Now I'll turn the call back over to a not for closing remarks.
Thank you Jeff.
While the macro headwinds I realize our leaders up everything to a focused approach for executing on refresh strategy for horizon one.
Over the last few months, we have works closely with third party Consultings down and give us an informed outside his view of what we're doing right and how to do a better.
And what we're doing wrong and how to fix it.
American equity like any company over the years has developed internally beliefs that need to be question any phone one thing you need to be jetson.
We found somebody needs to be fac like the importance of service and renewal crediting history in the seems decision by an independent agent.
All else equal.
So this and strong renewal crediting history will get us a scene.
On the other when we came to realize that in certain environment, Exxon spend and easily understood multi asset class indexed good performed when and should be an added add in the produces cuiaba case in point destinations 10.
Additionally, product design needs to anchored in both client and distribution insight and equally importantly in an ability to source and underwrite assets that produce appropriate risk adjusted returns.
The latter reflecting both the risk of ultimate NOL and ratings migration risk.
Therefore, strategic and tactical asset allocation will be all paramount importance.
And the work that our leadership team is doing very diligently expand into non traditional.
Core fixed income asset classes will be even more accelerated we the focus it investments, providing strong structural or contractual cash flow support.
Casing point is the partnership we executed this quarter with a leading specialists from across the whole residential lending ecosystem from me from origination to servicing and disposition of nonperforming assets in the nonqualified mortgage for loan market.
This is a good example of how we approach new sector.
Not just trying to buy security than it had an attractive valuation.
Back within approach to manage the underlying collateral to both the ups and downs.
Often economic cycle.
While equalize seems good targets on Northrop primary focus for 20 to 20.
The residential nonqualified mortgage loans, we actually achieving match up very well without liability that eagle life, enabling us to lift truck gaps and Eagle select focus five and seven.
Levels at least equal to our nearest competitor as accounts, where we have distribution footprint.
With that.
I will end up prepared remark on behalf of all might be made to the American equity. Thank you for your time and support operator can we open up to nine for questions.
Certainly ladies and gentlemen, if he's a question at this time please press the star and the number one key on your telephone.
The interest this time.
One question and one follow up.
So from the press the pound.
Our first question comes from Pablo.
JP Morgan your line is open.
Hi, I'm not so I found your commentary on 'em asset management interesting I guess, just a follow up and what you've said very broadly what kind of changes are you considering for your asset management capabilities is it Parker and with more third party managers expanding your in house stuff.
It may be acquiring small platform of the broader capabilities have to be sort of expand and how you're thinking about that's a management function appeal.
Hi, Pablo good morning, the answer is a combination of all of those so when you think a small and midsize asset managers any of those combinations could work for us specifically sector that the first sector. We are really looking at very hard.
Real estate.
Across the spectrum <unk> residential and other opportunities there.
Got it.
And then I guess a numbers question maybe.
Best for Ted So the investment loss and limited partnership you booked in the second quarter is to be able to expect that you might to recoup some of that in the third quarter.
Pablo in regards to that some of those and Caesar and partnerships that we mark to market where coal bed related.
So it's hard to say what recovery would be from a hopefully we wouldn't see further decline.
But as I said some of those partnerships, where energy transportation hotel leisure. So they were cobot impacted so recovery would be left funds left on those type of partnership.
Got it thank you.
Our next question comes from.
Citi. Your line is open.
Thanks, Good morning.
In terms of sales, but it seems like there's been somewhat of a divergence in industry. This quarter with some companies. It seems like maybe one more associated with alternative capital providers sitting pretty strong result, but most others and kind of more depressed levels. Just wanted to see if you'd agree with that assessment and if so kind of any thoughts on the drivers I guess, maybe said differently how much of the the slowdown in.
So that you've seen would you say due to industry wide pressure versus your products, maybe screening is little bit less competitive versus some others.
[noise]. Good morning. This is Ron Ron Grensteiner I would probably agree with your assessment, it's a mixed bag.
I think the majority of the company's though have sales lower in the second quarter or like they did in the first quarter. I think there are some outliers that maybe have a little bit of success I think the things that we point to for those companies, though they might have that a little bit stronger and the multiyear guaranteed annuities versus the fixed indexed annuities.
You know and when you're limited the social this gene and some virtual sales the multiyear guaranteed products.
There are a little bit easier sale to mix than fixed indexed annuity but.
Overall, it's just it's been a mixed bag so I agree with your assessment.
I'm, adding it to get to Ron said, we just brought on which is we do like the fact that the fixed index annuity business more than the MYGA business and we think Thats a more sustainable business you can go off for opportunities in the MYGA business based on asset sourcing, but that's a much shorter business was also the fibers.
Got it. Thanks, so much and then in terms of just spreads I guess if interest rates stay at current levels is there any color you can provide on how much incremental pressure on yields from from floating rate assets, we might expect in the third quarter and but beyond the third quarter is there any further downside pressure would that be mainly.
Finished and then.
You know related that how much of any of that pressure do you think you're going to be offset with renewal rate actions versus lower option costs, just any kind of general thoughts out would be really helpful.
Hi, This is Pat so in regard to the floating rate we would expect.
Where LIBOR is that the majority of that reset from the third week of a corridor that we'll probably see another seven to eight basis points and decline in yield from the decrease in the rates on the floating rate.
Going forward, you know assuming that investment partnerships don't decline any further in all that that won't occur. So that was eight basis points that occurred this quarter.
And then on probably drag from as we go forward and maybe from reinvesting at rates lower than the portfolio yield could be a couple based.
Our setting that is going to be if we as we go through the year make the determination depending on the economic environment and start to reallocate our cash balance which were holding night, a very liquid cash balance about 1.4 billion. If we started to reallocate bad and put it that into.
Alpha generation.
That would also offset some of the decline in yield that we'll see from the floating rate.
Got it thanks, so much.
Thank you next question comes from Mark Hughes.
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Yes, Thank you and I think I'm curious so with your review of the a of the business and looking at the.
Even so making some adjustments any thoughts on the stated technology any particular investments you might need to make there over the next to your so.
Hi, Mark Great question, Yes, we from a technology point of view.
We over the years, having being one of the founding players in this fixed index annuity business had met distribution wed want to be met.
When it comes through which has been a locker on phone service.
Face to face interaction.
That comes to custom experienced it is a shift towards wanting more self service in online and that's probably been in there where we are going to look to do that.
As we look beyond horizon, one it probably means that having a low cost operating cost structure.
If we can continue to do that with the Louis construction industry that may open up other options for us.
It's slow down the road.
No that used to kind of a very broad question feed Jeff when you can do it did portfolio how much support you think there had been on the valuations related the fed actions and thus the.
Government support the tapers to think that means much for your your holdings.
Oh I think on maybe some of the structured assets, there's there's been quite a bit a lift, especially in like CMBS and close on the higher quality tranches is kind of helped lift the whole capital stack on on the structured asset side.
Across the other asset classes I think theres been a strong enough demand just from cash that's available in the market wanting to get put to work them and you're seeing cingulate corporate spreads at 90 94 basis points on the index and that's.
It's almost close to a pre a pandemic level. So I think we've seen.
On the public credit side, you've seen quite a bit curing and I think thats.
Been more around demanding comfort that the economy are showing some signs of of starting back up but I do think that the fed buying of some of the structure side is really help help prop up some of those.
Valuations.
Thank you.
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Next question.
Uh huh.
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No.
Hi, Thanks for taking my follow up so the first one was for Ted.
You had mentioned that the cost of options was flat sequentially and I was wondering if you could provide.
Watercolor and how that's looking into the third quarter or is it better flat.
More expensive than just any color you could provide there.
Sure sure problem.
So as I said before on on the call here on the cost of options on American equity life. During the second quarter averaged about 154 basis points.
For the hedge weekend at July 28, the cost of options at American equity life was 136 basis points.
Okay.
And then.
Sorry.
Go ahead.
Well it totally was that it most extreme the cost of options that a email one to 100 and stuff.
Basis got it.
But we certainly see on retraction.
Got it.
And then on the new money rate.
It seems like you've got a great in the second quarter I was wondering if that's more reflective of surf one off deals. He saw in the market than I I know that they'll be able to use can change depending on which can buy but do you think that's more one off are reflective of what do you can actually purchase in this market on ongoing basis.
Yeah, and I'm going to talk about new money rate and two different pieces one on.
Putting actual money coming in on new business, that's probably around the 350, maybe up to the 375 would be our expectation.
But as we go forward and we talk about our total search.
Got actually could go higher as we do reallocation of cash or funds coming off of the portfolio. Maybe some corporates that are supporting enforce business and allocate those into other alpha generating assets.
Got it.
And then last one for me.
And just for you again 'cause it's for its sort of question about assumption review and I'm not gonna have what it will look like but maybe it'd be helpful that he can surf just elaborate on your process for setting you know interest rate assumptions what inputs, we consider witness the bodes do you apply and I guess more specifically, if you're using something like an intra generator.
How sensitive is out there to current market levels versus historical long term trend and maybe a more subjective forward looking assumption.
Yeah, as we've talked about before you know when we unlocked.
We were using a threeg 80, obviously with a 4% 20 year Treasury.
We were grading too we back that down to about 380, I mean, certainly we're going to look at the current economic environment. The current economic forecasts and what projected out into the future interest rates look at look like over a very long period and.
But we do need to take all of that into consideration as they look at what that Grace period would be.
And over what period, we need to reassess are great period of 20 years, we need to assess reassessed ultimate would be but the process is going to be looking at all of those bear in.
Into the process.
And using judgment to assume what overall long term interest rates will look like over that period of time.
Okay. Thanks for your answers.
Our next question.
<unk>.
<unk>.
Hey, guys. This is actually Allegan for Eric can you just talk about the changes that Eagle life, and how you see the opportunity for that business looking out to 21 and sort of how quickly you think the sales can ramp.
I think it's an on both start.
So eagle life for US is it really important channel, but be we'd be many measured in how we build it out we've got product now over there back than some of the new assets, we had originating that's very competitive.
And we clearly have converted to a more sustainable wholesaling strategy, which is we have predominantly our own wholesale is going in.
But in many regards it's a significant reboot, which means you need to get the write down into the rights in the bus which is why we think at the 2021.
Ramp upward over the long term that is a multibillion dollar channel for us, but it's going to take us.
12 to 18 months to talk about volume and billions over there, it's Jimmy I would guide.
Got it okay.
Okay. Thank you.
[noise] thing.
I'm not showing any further questions at this time.
Okay.
Two.
Oh.
[music].
Thank you for your interest in American equity and for participating in today's call should you have any follow up questions. Please feel free to contact us.
Ladies and gentlemen.
Thank you.
Disconnect everyone have a good.
[music].
Oh.