Q2 2020 Athene Holding Ltd Earnings Call
I'll be your conference operator today at this time I'd like to welcome everyone to be seen second quarter 2020, <unk> earnings conference call and webcast. All participant lines have been placed any listen only mode to prevent any background noise.
After the speaker's remarks, there will be a question and answer session. If you'd like to asking question at that time. Please press star one on were telephone keypad. If you should need operator assistance. Please press star zero. Thank you I'll now turn the call over to know what gun head of Investor Relations. Please go ahead.
Hello, and welcome everyone.
<unk> earnings call joining me this morning, our jumble arty chairman and CEO.
Wheeler President and Marty.
Oh officer.
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Forward looking statements and projections, which do not guarantee future events.
We did revise or update such statements to reflect information subsequent events or changes in strategy.
Prior to our most recent quarterly.
<unk> 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 our relevant assessing that financial performance of the business.
So what do you sense of these non-GAAP measures can be found in our earnings presentation and financial supplement which are available.
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I will now turn the call to gymboree.
Yeah, Thanks, and good morning, everyone.
Thank you for joining us today, and I Hope you and your families are safe and healthy during these unprecedented times.
Despite the ongoing extraordinary circumstances, we are faced with in the current environment.
Hi, I'm pleased to report that a teens investment spread business remains a bastion of consistent and growing strength.
We are extremely well capitalized with over $14 billion of regulatory capital.
And then under Levered clean balance sheet.
Our financial strength ratings are all recently affirmed at an a level by our three rating agencies.
And we've experienced almost no impairments in our investment portfolio year to date.
We're not only built to whether the current storm. We're also built to capitalize on it.
Since our inception, we have extol, the virtues of holding excess capital.
With a view that profitable growth is most available when capital is most scarce.
Our second quarter performance is a testament to that fact.
During the quarter.
It was in the industry without our strategic asset management advantage and significant deployable capital.
We're forced to pull back from new business origination.
Preliminary estimates from LIMRA.
Report that industry fixed annuity volumes fell 4% quarter over quarter.
While our retail sales increased 44% by comparison.
We are incentivized by profitability editing.
Not volume.
By simply executing our business strategy, which includes maintaining our pricing discipline.
Getting opportunistically across our funding channels.
And supplying capital to support new business.
We were able to generate record quarterly organic volumes of nearly $7 billion out of 27% return a record combination for a thing.
This is confident confirmation of the resilience of our business and our team.
Demonstrating our ability to serve as a source of strength for our policyholders and business partners amid volatility.
Well, we are diligently executing in our day to day organic channels.
We're also looking for opportunities to act as a solutions provider.
Amid the ongoing restructuring across the insurance industry.
During the quarter, we closed on the largest known block reinsurance transaction by partnering with Jackson National.
And its parent Prudential plc.
This is a compelling transaction that added nearly $30 billion of high quality liquid assets and fixed and fixed indexed annuities that we know very well.
Most importantly, the returns are compelling.
And at closing the transaction did not use any of that scenes excess capital.
Hey unique value add combination.
Hi, I'm very pleased that we were able to work with members of the Jackson and Prudential teams to structure a transaction.
In which all parties created or unlocked voggenhuber value for the respective shareholders upon announcement.
Our ability to create win win outcomes by leveraging our competitive advantages.
Including our scalable efficient infrastructure, our ability with Apollo to drive alpha within our investment portfolio.
Our access to capital in our a credit ratings.
Reinforces our status as the preferred solutions provider and trusted partner toward growing list of Blue chip called Counterparties.
The full strength of our business is best displayed when you're able to execute our organic and inorganic strategy is kind of currently.
Driven by what we expect will be record organic deposits for the full year.
Plus Jackson.
We expect to add $50 billion of gross deposits for the four year.
This equates to 40% annual growth in invested assets.
Hey, very impressive accomplishment in the face of the current pandemic.
Our team is intently focused on maximizing earnings while maintaining our risk discipline.
We are working hard on the investment side with Apollo to quickly invest our excess cash.
Prudently redeploy the inherited Jackson portfolio.
And to capture a tractor spreads on the cash from our daily organic deposits.
We purchased more than $11 billion of investments in the second quarter.
At a blended 40 basis point premium net of fees.
To the Triple B corporate Bond index.
Demonstrating the alpha generating nature of active investment management.
Our activity can be summarized across three primary buckets.
First despite the rebound and tightening we saw in the second quarter.
Were still seeing wider than normal investments investable spreads in public and private corporate bonds.
Which accounted for about 70% of our purchases.
Allowing us to transact quickly in size within deep liquid markets.
Second we are seeing attracted a decimal spread opportunities for structured securities such as.
Yellows, RMBS and asset backs.
That accounted for roughly 20% of our purchases.
As a reminder, we focus on the senior investment grade tranches of the structured securities.
Which benefited from significant credit enhancement.
And enable us to pick up incremental yield at a similar rating profile to our corporate purchases.
In the third docket, we have differentiated solutions.
These are bespoke investment opportunity that often come up through our affiliation with Apollo.
This quarter, we participated in a transaction with and that's a financial they publicly traded mortgage riet.
We partnered with Apollo and other third parties to offer a holistic financing solutions around that day.
Given the themes familiarity and historic success investing in residential real estate.
The investment was a natural fit.
Ultimately opinion deployed nearly a billion dollars of capital in the form of asset backed term loans and a secured and a senior secured term along with warrants.
The capital was invested at a spread premium over 400 basis points versus pre cold and pricing.
For what we believed to be equivalent risk.
With this backdrop of the investing environment in mind I'd like to connect the dots in terms of how it translates to our forward earnings power.
On our Q1 call I spoke about how we were holding a higher than normal level of cash available liquidity in our portfolio.
To be opportunistic amid the market volatility.
While conditions remain fluid given the market rebound in spread tightening we saw in the second quarter.
We now expect to deploy more than half of the $5 million and cash balance we had at the ended the quarter.
Excluding amounts related to the inherited Jackson portfolio.
We expect to do this before the end of the year.
This will return our cash level to a more normalized on balance sheet level of approximately $2 billion.
Underpinning more than $5 billion of total available liquidity.
Which includes other sources of committed liquidity as well as our revolver.
Deploying excess cash balances will increase annualize investment income by approximately $120 million.
Which should increase our fixed income yield by approximately nine basis points on a run rate basis.
As it relates to the Jackson portfolio, our intention is to redeploy 75% or more of the nearly 30 billion of investments.
We inherited to better align the portfolio with opinions alpha generating asset allocation strategy in investment grade credit.
I'm pleased to report that we are ahead of schedule since the deal announcement on June 18th.
We have reinvested more than $6 billion or approximately 30% of the volumes in our redeployment plan.
We estimate our redeployment activity will be substantially compete substantially complete by the middle of next year.
At the end of July the net book yield of the Jackson portfolio was 2.4%.
A 60 basis point improvement on the overall portfolio from the 1.8% yield at the end of June following the monetization of the Treasury Securities.
As we continue to redeploy we expect the yield on the Jackson portfolio to rise towards a yield of our existing portfolio.
We underwrote the transaction to our attractive target return for inorganic growth.
And in line with our prior communication, we expect to deliver earnings accretion of 6% to 9% and 2021 and 2022.
Which equates to approximately 90 to $149 of additional adjusted operating income.
I'm now going to turn the call over the Bill and then I'll be back to close our prepared remarks.
With some additional comments on our investment portfolio and capital.
Bill.
Thanks, Jim.
As you can see from our results our business operations performed extraordinarily well under the circumstances in the second quarter.
Despite a remote working environment, our team source record organic deposits and closed our largest inorganic transactions since 2013.
In the face of macroeconomic uncertainty as well as a historically low interest rate environment. These results demonstrate the strength and resilience of our multichannel distribution model.
As Jim discussed we generated record quarterly deposits of nearly 7 billion in our organic channels, resulting in more than 75% sequential growth.
And importantly, we did not have to stretch to achieve these volumes on an aggregate basis underwritten returns on organic deposits in the second quarter came in very strong as Jim noted well above our mid teens pricing targets.
There were several dynamics that made the quarter, a great opportunity to originate new business.
First our ability to invest in a wider spread environment synchronized with some of the lower funding costs. We've seen in the past decade was instrumental to our near record underwriting margins.
Second we witness various companies that were more aggressive last year pullback substantially either because the rate environment compel them to reduce pricing the less competitive levels well they had a desire to conserve capital.
Well it may not seem intuitive given overall industry pressures our position in this type of environment got stronger and overall it was an ideal time to be in the spread liability business.
Turning to each of the channels in retail we generated 1.8 billion of deposits in the quarter up more than 40% sequentially.
Supported by our strong capital position a theme has maintained its presence was an industry leader and a source of strength for policyholders and gain market share, while maintaining pricing pricing discipline in stark contrast to numerous competitors, who pulled back to conserve capital.
Additionally, the breadth of our distribution capabilities, which include a growing presence among financial institutions proved advantageous in the second quarter.
Several key partners were able to continue their retail annuity sales to their leading digital platforms.
As a point of reference nearly 40% of our retail annuity sales in the first half of 2020 or generated through bank and broker dealer channels and we anticipate that there could be additional growth over the long term.
I'm also pleased to announce that our new distribution relationship with LPL financial went live in the back half of the second quarter.
And while it will take months to fully onboard the ranks of their deep advisor pool. We are encouraged by the early progress we've seen and view the relationship as a significant growth opportunity.
Moving forward, we anticipate retail volumes in the back half of 2020 could remain strong around second quarter levels.
In flow reassurance record quarterly <unk> deposits of 2.3 billion were driven by outsized retail annuity sales from key partners, particularly those with a strong digital presence.
Well quarterly flow reinsurance volumes can fluctuate based on counterparty appetite and quota share levels. We're very pleased with the strong second quarter results.
A wider than normal spread environment, we were able to offer competitive pricing, which drove particularly strong volumes in may and June at attractive returns.
Looking ahead, we anticipate reinsurance volumes could moderate from a record level seen in the second quarter as we observe others coming back into the market. Although we expect activity to remain healthy overall, reflecting momentum with newer counterparties.
As you know the majority of our overall organic origination costs from the U.S., but we have been making a conscious effort to see if there are other markets, where we can leverage our competitive advantages to drive additional growth and diversification.
These lines you may recall that we've discussed the inroads we have made in the UK to provide pension solutions. Similarly, we have been evaluating the large Japanese fixed annuity market for sometime.
I'm pleased to announce that we established a new fixed annuity flow reinsurance partnership with a large Japanese financial institution that became effective in July.
This marks our entry into the third largest annuity market in the world and presents a meaningful long term opportunity as well as further geographic diversification of our business.
Turning to the institutional business, we generated 2.6 billion of deposits, primarily driven by record activity in the funding agreement child.
The quarter's activity was driven by three sizable at baby bond issuances totaling 1.4 billion.
Which included our inaugural Euro denominated issuance as was a heightened level of issuance will be FHLB totaling 675 million.
The second quarter result was more than triple the activity in the prior corridor and doubled the 1.3 billion of issuance, we had and all of 2019.
As the spread environment tightened event, the second quarter market rebound, we took advantage of the opportunity to achieve very attractive returns.
Well, we anticipate issuance in the back half of 2020 will moderate from the very strong second quarter result.
We remain optimistic on the pipeline, including the potential for another non U.S. dollar denominated deal by the ended the year.
And P.R.T. actively or activity moderated during the quarter as expected.
We closed one transaction with a large packaging company in April as previously communicated.
The pipeline of U.S. PRT deals expiries quite strong in the latter half of this year, we will remain active in bidding for transactions that come to market and we're optimistic that our activity will recover from the second quarter lows.
Pulling it all together, we anticipate our aggregate organic growth activity in 2020, well exceed our prior guidance of 15 to 16 billion.
And like we had 20 billion inline with the 50, but at a gross deposits Jim highlighted earlier, which would be a remarkable result in the context to the economic backdrop.
On the inorganic fun I'd like to highlight a couple additional elements of the Jackson transaction, while also providing some context then how we're viewing the opportunity set from here.
First well we are willing to engage in a more traditional M&A activities, such as corporate carve outs and whole company acquisitions. The block reinsurance transaction structure, we employ with Jackson offers tremendous efficiencies with minimal execution and integration risk.
Given the deep bench or talent, we've built to support our inorganic capabilities and managing additional assets and liabilities. We can execute a deal like Jackson were bolting on a $30 billion block of business and we don't need to invest in a lot of new resources, a testament to our highly scalable infrastructure.
Furthermore, the close time frames are often much shorter so we can deploy capital and get to work on driving accretion much faster.
Second when we work with our partners at Apollo to raise more more than 3 billion of strategic sidecar capital last year, we look forward to the capital flexibility additional growth capacity of would provide.
As far as we can tell ACA remains the largest pool of on the bank capital in the industry, allowing us to transact with more frequency and grow our business faster.
Third the Jackson transaction builds on the past successes of other deals we've done, including a veeva voya and Lincoln among others. Each time were successful at creating a win win outcome for our counterparty on ourselves.
Reputation as a solutions provider grows and we receive inbound calls from new potential partners wanting to have a conversation.
We have more than 7 billion of deployable capital available net of what's your Mark for Jackson, which translates to over 85 billion of liability purchasing power.
Following three sizable fixed annuity transactions executed in the market. This year, including ours, you may be thinking that the opportunity set from here is less robust however.
Pipeline is quite strong.
We continue to see a range of potential targets in the marketplace and well some counterparties are willing or waiting for more economic clarity clarity summary remain engaged in discussions to explore strategic transactions.
As we've noted the industry continues to undergo significant consolidation and restructuring to reduce exposure to complex liabilities.
Noncore businesses or exit whole businesses or geography is altogether.
We anticipate this will continue and perhaps accelerate in a prolonged low interest rate environment.
Additionally, there continues to be a significant gap between public and private market valuations in the life insurance in annuity industry as evidenced by the recent transactions where business is I've been acquired at multiples well above for public comps are valued.
Ultimately these gaps in value recognition will be closed you through the public market recognition or more M&A activity.
With that I'll now like I'd now like to turn the call over to Marty will discuss our financial results.
Thanks, Bill good morning, everybody.
What are the key messages, we'd like to reinforced with you today is that we have a very resilient business model that can generate attractive through the cycle returns, even when experiencing bouts of volatility where periods of low interest rates.
At a high level or second quarter financial results benefited from a sharp rebound in capital markets, most notably for Apollo or A.O.G. investment.
At the same time, our results were also burdened by first quarter market depreciation impacting alternative investments marked on a lag basis as we expected.
And our earnings presentation, you'll see that we've provided an illustration to help convey our core earnings power.
Your retirement services, which excludes the benefit of the O.G. investment.
If we normalize alternative investments toward our long term return levels to immunize, the transitory volatility of the first quarter.
You can see that our earnings profile remains strong and they're at our ROI lead generation remains compelling in the mid to high teens.
This can be credited to the strength in profitability of our spread based model even in the low rate environment.
I'm not spend some time, taking you through the key components of our operating results.
Starting at the top of the income statement or large enforce business produces the mostly consistent and predictable fixed income near.
That said there are numerous factors, including macro and business development that can cause it to move.
Quarter over quarter impacts were largely driven by known factors, including lower floating rate income from declining interest rates cash drag from prudently holding more liquidity mid market volatility and onboarding. The Jackson transaction, which is a very low incoming yield of approximately 2% prior to redeployment efforts.
These items combined these items combined accounted for nearly two thirds of the sequential decline, but more importantly cash drag in the Jackson Onboarding are temporary in nature and should reverse overtime as we redeployed those funds.
In addition, we experienced a moderation in bond call and RMBS prepayment income, which adversely impacted second quarter results, but which will benefit income in future quarters, corporate said than less likely to call their debt in this environment.
Well in our seasoned non agency RMBS portfolio individuals prepaid as it's somewhat lower rate pushing out some of the amortization of discount on these bonds into future periods.
Given the various levers that can move the fixed income here, let me walk you through the trends that we expect to emerge in the back half of the year and beyond.
Our forward earnings will benefit from deploying excess cash and liquidity capturing attractive on the margin spreads on new business as well as from the ongoing Jackson redeployment.
However, in the very near term, we expect some additional drag from Florida resets as well as the presence of the lower yielding Jackson block in our results for a full quarter to result in a combined headwind of approximately 15 basis points in the third quarter.
Accordingly, we expected the third quarter will represent an inflection point for our fixed income near and the benefits of our investing activity will lift the yield higher in the fourth quarter and even higher from there in 2021.
Our full year 2020 fixed income near is now expected to be approximately 3.8%.
As we've noted previously our expectations assumes stability around to the is forward rate curve and current market conditions.
Given short term labors LIBOR as proximity to zero well they have floors on close to half of our floating rate portfolio.
We believe our earnings potential from floaters is asymmetric in skewed to the upside at current levels.
Turning to alternatives as we expected performance was bifurcated between 40% of investments, which are marked on a real time basis and benefited from the market rebound.
Versus the 60%, what you're marking a lag basis, reflecting the delayed impact of first quarter volatility.
Our real time investments appreciated 8% in the quarter on an annualized basis, while our lagged investments depreciated, 8% also on an on annualized basis, driving a blended decline of less than 2% in the quarter on annualized basis.
This is a better results than we projected due to better performance on both parts of the portfolio and Jim will provide some additional comments around that in a moment.
Moving into the third quarter if markets hold at current level.
Our best estimate is that our alternatives portfolio will generate a higher than normal net investment earned rate of 11% to 13% due to the positive impact on lag investments.
For the year, we'd previously expected alternative income would be roughly breakeven, but with the second quarter market rebound, we now expect or full year alternatives near to be in the low to mid single digits.
Moving next to cost of crediting reported rate declined five basis points quarter over quarter consistent with the downward trend in a low interest rate environment.
This result was mostly driven by lower crediting rates on the institutional side of business.
Institutional benefited from active funding agreement issuance in a low rate environment as well as a favorable PRT mortality results.
Meanwhile, although rate resets continue to benefit our enforce annuity business.
The Onboarding of Jackson reserves drove up the reported cost of crediting on deferred annuities by three basis points sequentially.
I'd note that the Jackson liabilities have somewhat higher credited rate than our annuities book.
Would have a lower level of other liability costs.
As we count for the full quarter impact of Jackson, we expect overall crediting rates to rise in the near term and come in between 180 to 185 basis points for the full year.
For other liability costs represent the other part of cost of funds for our deferred annuities, we observed quarterly fluctuations that can occur as a result of significant short term market movements. As we also saw in the first quarter.
The second quarter ago liability costs were lower than normal as the S&P jumped 20% in the quarter following a 20% decline in the first quarter.
Additionally, other liability costs benefited from less amortization expense, resulting from lower gross profits and related income from alternatives.
As well as the Onboarding of Jackson, which carries a lower rate above the liability costs than our in force deferred annuity business.
Looking forward and assuming no market impacts given the Jackson liabilities and a higher mix of Inforce institutional business, we expect other liability costs to be closer to 85 basis points in the back half of the year versus the normalized baseline of roughly 100 basis points, we'd indicated previously.
Shifting to our platform costs DNA expenses are stable line item with the downward trend expected overtime as we grow our DNA dollars grow but more slowly because of the scalable nature of our platform.
The ratio of DNA dollars to our assets has been steadily declining overtime and we expect this long term trend to continue.
With the Jackson assets added to our platform as well as the robust organic growth given bill spoke about earlier, we think operating expenses as a percentage of average invested assets will come in at around 25 basis points in the back half of the year lower than previous indications.
Turning to taxes as a reminder, our tax rate is a function of how much income we generate in our Bermuda subsidiaries.
Versus our U.S. subsidiaries.
The stronger than expected market rebound in the second quarter the mix of our profitability improved our outlook for the year.
So the second quarter tax rate benefited from the full year true up.
Previously, we didnt vacated the mid to high teens tax rate for the year, but we now expect that that could be closer to mid teens level. This year due to improved expectations for overall profitability and income mix.
Ill now move to our investment and the Apollo operating group entities as a reminder, or equity interest in energy is mark to market quarterly and the after tax impact if any change in fair value is accounted for in a single line item with our operating results.
In the second quarter, the price of Apollo's publicly traded common stock rebounded sharply increasing almost 50% on the quarter. Following the market volatility that we saw in the first quarter.
Additionally, we received dividends on our energy investment.
No the liquidity discount of approximately 10%.
Taxes of slightly more than 20% the change in fair value of our A.O.G. stake was 372 million or $1.79 per share with that I'll turn the call back over to Jim.
Hi, Thanks Marty.
Before we take your questions.
I'd like to address a couple asset classes in our investment portfolio, which had been areas of heightened focus recently.
First the credit quality that seems overall investment portfolio has remained solid.
With only one basis point.
Oh T T I in the second quarter two basis points in the first half of 2020.
Our portfolios experienced minimal downgrade year to date.
Which netted upgrade has resulted in only 13 points of drag on our RBC ratios.
Which remain very strong in the mid to high 400%.
Importantly, we continue to expect than any potential credit losses, resulting from the current environment will be very manageable, given our robust excess capital position.
I'd like to take a moment to highlight appease differentiated CLL portfolio.
Given the recent focus and media attention around the asset class across the insurance industry.
As a reminder, that teensy yellow investments, which currently comprise approximately 9% of our invested assets.
Our core competence component of our alpha generating asset allocation strategy.
By leveraging Apollo structured credit expertise, we can create meaningful incremental yield by investing in diversified pools.
Our senior secured loans with significant credit enhancement.
And additional structural protections compared to similarly rated corporate bonds.
In today's market the yield premium for Siloed relative to corporates is greater than 100 basis points.
In terms of credit quality.
99% of our CLL as our investment grade rated and 99% of the underlying loans our first lien.
Importantly, while steel those can exhibit mark to market volatility in periods of market stress.
We intend to hold these investments to maturity supported by the long term persistent nature of our liabilities.
We regularly stress our asset portfolio as you know.
And we would expect no principal impairments on our CLL portfolio in our baseline recession scenario.
Which utilizes more punitive stress assumptions for seal those than experienced during the great financial crisis in 2008.
To further support designed to provide you with all the key points about our CLL portfolio in one place.
We will be posting a dedicated presentation on our CLL portfolio.
Through our website later today.
Alternative investments currently comprised 4% of our nearly $140 billion net invested asset portfolio.
And our all start differentiated relative to traditional hedge fund and private equity investments.
That's a more defensive orientation.
That is less prone to binary outcomes.
Our largest holdings, our direct investments in high performing strategic operating businesses.
As you recall quarterly an alternative investment performance is impacted by mark to market movements.
Although this does not necessarily indicate permanent impairment.
How do we expected our alternatives portfolio has exhibited less volatility than public markets in the first six months or 2020.
The portfolio is currently earning at a greater than 10% annualized rate.
And has recovered to reduce value reported in the first quarter.
In the second quarter, there are numerous contributors that perform well.
Amerihome delivered a particularly strong result.
Driven by gain on sale margins elevated origination and refinance volumes from low interest rates.
As well as hedge gains on mortgage servicing rights.
Elsewhere in the portfolio mid cap on middle market lender saw recovery and its valuation since the end of the first quarter.
And it continues to be well positioned to whether the current uncertain economic environment.
Reflecting a strong capital position, which was bolstered by his recent equity raise.
A thorough which is viewed by some as an early stage as seen in Continental Europe.
Close their transformative acquisition a V Vod in early April.
Which increased their general account assets by five times to 70 billion Euro.
And they raise more capital to pursue additional growth.
On the back of this activity, we funded our commitment to support a SaaS growth.
Upsizing our investment materially.
We look forward to remaining partnered with your thought team going forward.
Finally, as it relates to capital we remain very well capitalized post the Jackson transaction.
With more than 14 billion of a statutory capital and 7.3 billion of total deployable capital.
Comprised of 3 billion of excess equity capital, two and a half billion of untapped debt capacity.
And 1.8 billion to third party capital remaining inaccurate.
We expect to deploy capital inline with our four primary uses.
Continue generating strong organic growth.
Close on additional inorganic opportunities support our ratings and drive upgrades over time and executed accretive share repurchases.
It is very clear to us and to you as well that athene shares are significantly undervalued.
Relative to our strong fundamental performance in our attractive prospects.
Accordingly, we plan to resume our share repurchase activity.
Utilizing a measured approach as we continue to monitor economic conditions.
We are leader in the channels in which we operate and a preferred solutions provider to the industry.
While we have spent the last the pass 11 years penetrating the U.S. and Bermuda.
We still have plenty of runway.
We've also diversified our business in new geographies, including recent pension business in the UK.
Our strategic relationship for sister company, a thought where we are the largest investor.
Which is scaling in continental Europe.
And our new flow reinsurance partnership in Japan.
We're now a growing from global company with an expanding reach.
Within our core market and newer growth plans around the globe, there's an abundance of opportunity in front of us.
In closing our second quarter results confirm and I remain very confident that the theme will emerge from the current environment far stronger than when we entered.
We will continue to grow our core earnings power and generate exceptional industry, leading returns for our shareholders.
With that I'd now like to turn the call over to the operator to take your questions.
Thank you at this time, if you would like to ask your question. Please press star one on your telephone keypad. If you wish from those yourself from the Q you may do so by pressing the pound key.
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First question comes from the line of Tom Gallagher of Evercore.
Good morning, Jim I, just want to I. Appreciate the comments you made on on the credit side, I think Thats where <unk>.
Certainly I'm most of the concerns that I hear come from and probably weighing on your valuation the most but I guess my question is how do you balance.
Favorable asset prices that we saw in the big recovery.
In my mind to large part driven by the fed key Lee.
What appears to be the poor conditions in the real economy.
Hi, how are you balancing not because it does look like if you want to de risk, there's an opportunity today, but it doesn't sound like you're inclined to de risk. So maybe maybe talk a bit about that that balance and also if you are as confident as you say in CL lows in some of the other say higher.
Gilding exposures you had what are the pockets of fixed income that you're more worried about that you think you see.
Asymmetric risk word on the downside.
Yeah. Thanks, Tom.
Uh huh.
Uh huh.
We're not out of the woods by any stretch of the imagination. I mean, this pandemic is going to have a long lasting effects.
Into 2020 or 21 in some sectors beyond 2021 and in some cases things are never going to return to what they were before [noise].
So.
Even before the pandemic Tom <unk>.
We were always looking to make sure the credit quality of our portfolio.
With where we want it.
We generate a lot of gains from from the Jackson portfolio and selling the treasuries, which are key to the economics of the deal.
And we've continued to.
Sal and what we think are potentially problem credits.
Some candidates that for downgrades that would move from Triple B the double b.
Just think it was a prudent economic thing to do.
So.
We're going to experience some losses, and we don't think they'll be outsized compared to others and certainly within our risk appetite.
Continue to say and sell convinced as we speak today.
We have much more risk downgrades than we do to defaults.
Sure.
Prone areas or what do you expect I mean.
Airline does having having.
Some trouble Aki care fund has deal however is doing quite well.
<unk> attachments and the ltvs their low to mid Fiftys and.
He is performing well.
Within asset backs.
Right.
Yeah.
I think and.
There's been some downgrades in the fleet.
Lease rental car space whole business and aircraft those are all areas of watching you know, we don't have a significant amount there, but we have some.
Our commercial a mortgage portfolio <unk> is doing very well.
Hold on a second to have some life in for July as the end of July we successfully collected debt service payments for 99.9% of our CML positions.
The only two delinquencies totaling 6 million of outstanding balance.
As I said in the past I think look we're going to.
Get significant player in both commercial and residential real estate, but if we had to emphasize one of the other we'd emphasize residential building out people staying in their homes more than they.
We'll return to work just like they did before the pandemic.
And we asked particular expertise and the residential real estate I mentioned the transaction, we did with them I pay but I portfolio.
Subject to some volatility on prepayments et cetera.
The credit quality is just as we had expected so [noise].
We continued to be under way high yield.
When we get extra yield we don't go down the capital structure and take more credit risk instead, we think.
It's more prudent and so far the results of borne out to generate yield through illiquidity.
And substructure risk so.
It sounds like a common refrain, but but we're cautiously optimistic but it's we got a long way to go to really have things out of the marketing Chad has helped no doubt about about it but.
I hope that answers the question, but those are the things that we look at.
No I appreciate that that was a comprehensive about sort of what you're thinking on that and I get my follow up is.
Marty your your slide which shows the fixed income near.
I guess as kind of a sample.
Paths forward of 3.8% in 2021, what do you see that translating to from in Norway standpoint, overall, I know you guys had talked.
In the past about 110 to 120 basis points I'm, assuming that's probably off the table now just given where rates are and some of the pressures, but I know you also mentioned some pretty considerable lowering of call it cost of funds or other liability costs as an offset to where where do you.
Our away trending into 2021 Marty.
Sure. Tom you know, there's some dynamics that were playing through our financials. This year that again, we think are largely transitory with the the alternatives marks and we still think they'll terms book is going to perform from here in line with our long term expectations of anywhere from 10% to 12% overtime.
And obviously interest rates have come down so that impacts our our floaters.
But we also do get reduced crediting rates on or enforced annuity book overtime with pets is kinda catches up overtime.
But it would just a reminder, on the slide we think we end the year. It's a 380 for the full year, but we kinda it has a greater than side and we think there's uplift in 2021 from that threeeighty rates, so it's greater than that.
And then obviously, we expect to allow us to recover listen I would say from a return on assets standpoint that is 2021.
Yeah, I think we kind of get to a level, where we were probably last year last year in 2019, we're around 110 basis points.
And I kind of expect.
Similar or away in that in net investment spread of about 150 basis points.
Do you think about a net investment spread in 2021, its things play through here, Yeah, our fixed income near <unk> will be a little bit lower than it had been if interest rates kind of stay where they are with the forward curve, but our cost of funds are we expect almost entirely offset that we've been putting on a lot of very low cost business and then what can.
Do you need a drop rates.
On the in force. So we expect our net investment spread to kind of be around a call. It 150 basis points next year and turn it assets to be close to 110.
And we probably think there's going to be more lift from there because in 2021, we won't have can totally completed the Jackson redeployment until kind of midway through the year three quarters away through the year and so 2022 again in a stable environment should be even better than that so maybe we get to 120.
Basis points of orally go in there.
Your next question comes from the line of Eric Basketball Autonomous research.
Hi, Thank you.
Given your excess capital position and strong growth momentum you're seeing how are you thinking about the different deployment options for capital do you see enough organic and inorganic opportunities to absorb most of the excess capital.
And I know you you mentioned, you'll be resuming share repurchases, but how do you think of.
Okay.
The level of that can get then there was a compelling as well with the stock trading at less than 70% of book value.
I'll start and I'll turn over to Bill yeah. Thanks. So.
We mentioned our for uses of capital we're going to.
Use capital for all four.
Look we're going to have cap was going to support our record organic premiums for the year.
Bill will talk about the inorganic pipeline, but.
<unk>.
We're talking to you we got a couple deals that were looking at that that are fairly significant.
Everybody knows that our stock is undervalued, so we're going to resume in a measured manner our buybacks.
[noise] and Oh, you know ratings upgrades were on the right trajectory there so.
Pretty much reiterating what I said on a call I'm not sure. There's just there's much more to add other than maybe bill can talk about the inorganic pipeline.
Oh, yes, Tim or Eric you know if.
You know if we do 20 billion this year, which seems pretty likely now and my expectation is is that's gonna grow I mean, we haven't put out a forecast for 21, yet, but you know there's no reason to think this is really a blip you know where Ah you know, we're continuing to take share we're getting into new markets.
Where so the organic growth machine.
You know, we haven't hit a peak by any stretch the in terms of deals.
I guess I think that.
You know we're already back in the market, where there are you know some smaller targets Theres also some big ones and and I think that there's a there's going to be an opportunity to get another deal maybe get a deal done this year. So some size.
Maybe you know certainly you know a lot of activity next year. The you know the issues that are causing companies to you know to restructure their balance sheets, you know I haven't changed if anything they have intensified and so and you know where the guy is one of the capital to help them you know facilitate that so I feel like we're going to have a chance to deploy a lot.
Of our excess capital over the next.
I'll call it 18 months or so.
I would just add to that I agree with everything Bell said I think the global.
Transaction, where they required at book value I think.
Has caused some people that have been on the sidelines on the seller side to kind of reevaluate whether it.
Maybe more robust valuations similar to what global went for.
To reevaluate whether they want to do something which is a positive thing I think its spring a few more a keyboard discussions than normal.
That's right. Thank you and then just follow up on the organic growth side, you mentioned some of the competitive dislocations in the second quarter is that continuing are you seeing something your competitors on both the retail side and reinsurance start to come back to market.
Fireman's getting a little bit.
More competitive.
You know maybe modestly more competitive, but we're not seeing much difference. It really if you look at other activity levels. So far this quarter we.
We're obviously just a month in the where.
No. The I don't think the environments change very much.
Your next question comes from the line of Andrew Clark of Credit Suisse.
Hey, good morning.
Structural product question, maybe first.
Mentioned, the new annuity product offering in Japan could you give some color around structure of that product.
What what is the market outlook there.
Yes, well if you know much about the Japanese fixed annuity market a lot of it historically has been sold in either U.S. dollar is around $30.
And with the idea being that the underlying investments or are in the are in Australia or the U.S.
'cause Japanese fixed income markets, you know I've always been so low yielding in recent.
Last decade, or 20 years or so.
This product is a little different it will be offered it's an indexed annuity.
The underlying index is a sort of a portfolio of Goldman.
Funds and it will.
And it will be a sole both in yen and in dollars and I think the yen being sold and yet and then you'll you know, we we manage the exchange risk or currency exchange risk kids and therefore invested the money in dollars I think is actually going to be a nice feature for the Japanese.
Sooner.
You know, we're only a few weeks then and I'm already pleasantly surprised about the volumes that are coming through so where and we're already having discussions with our second provider there so it.
And I would also just say if you look at the nature of the terms of the underlying fixed annuity.
The lapse rates are very punitive.
And Ah and it has a fixed you know maturity. So after 10 years <unk>.
You know the consumer has to decide to renew or not.
Oh, it with a new contract with new pricing so it.
So you know for risk profile point of view. It's it's you know, it's probably you know more conservative than what we saw in the U.S.
I see is the add on its at the surrender charges are very punitive not the lapse rates. The lapse rates are very predictable because of the punitive surrender charges. So it's almost like 10 year funny agreements in many ways and you don't plan to hedge the currency risk.
No, we definitely will hedge the currency absolutely.
Okay.
Well thank you.
Yeah.
Hey, Andrew having a hard time here and yeah.
Okay.
Oh.
Yes regarding the fixed indexed annuity structure.
Given the 40% increase in sales what you said you know in your offering that is so competitive versus the competition, what's the market participation upside versus.
Maybe the downside versus competitors I want to understand what wed need.
So strong.
Right. So the downside is is zero. Obviously, you know you don't it's not like a buffered annuity where you could actually lose some principle.
Here are the you know your yeah. Your your principal is protected and of course, that's why this is such a good.
You know retirement instrument.
The upside you know, we're offering participation rates on various indexes, which are you know.
You know, maybe 10 points higher than the competition in many cases it depends you know I'm. The other thing that makes our annuities March you know attractive is we yeah, we often times offer bespoke indices, which is you know is much more appealing I think too you know to financial advisors.
Oh, the offer something a little different than just typically the S&P 500.
I would say today, if you look at our in force probably half of it is tied to the S&P 500. So so we all do offer a little better participation rates.
Our comp we don't offer more compensation, our compensation is middle of the road.
And and so that's you know that's what's working what's happened of course, Andrew is our pricing really hasn't changed but our competitors have pulled back and that's and that's probably the bigger reason for the sales increase.
Your next question comes from the line of Ryan Krueger of KBW.
Hi, good morning I.
Jim I had a follow up on your question about the goal of Atlantic sale price that at book value. When when you said that that was causing you've got some companies to reevaluate.
Options with that comment more.
In regard to whole company, considering that option or or or reinsurance transaction.
I think I think both I mean.
Right as you know I preferred way to grow is exactly like we did with Jackson block reinsurance deal, we don't need the infrastructure people et cetera.
But we're flexible we can we can constructed deal whether it's a whole company just a block.
We've done to.
That way and each way several times and so we got experience and so.
Yeah, we're we're flexible on that but but I think both.
Our next question comes from Jimmy Bhullar JP Morgan.
Hi.
Good morning, So just first a question on.
More and more people expecting relates to stay low for the best period and that number is even better now but have you thought. They are you planning on any changes to your secure investment started either you either reduce or increase your exposure to putting that unless you're not getting paid much on those now.
Yeah, I know, you're right to would've been better economically or PML wise Ginnie, if we had dead.
Hedge those go we always thought or the presence of the floater I mean first of all portfolio our size.
You need to have some we think it's just prudent to have some floating rate exposure as well as mainly fixed.
We're going have sinus matter of what the right amount is.
[noise] like a win at the levels Weibo are now there's not much more can go we got LIBOR flow floors inherent in about half the floating portfolio LIBOR can't go negative.
If we get the coupon on top of that plus the amortization of the discount so [noise].
Well, we're not going to hedge or do anything different right now certainly at these levels.
I also would would let you know that when you are.
Our block when our block ages, we still got most all of the block on the annuity side is protected by surrender charges, but [noise].
The Jackson block had some things outside to surrender charge as well.
And the disintermediation surrender rate.
Could increase when there's no surrender charges when rates go up.
And the presence of the floaters on the asset side with rates going up the by more income does serve as a risk mitigant for us against those those potentially surrender bowl liabilities that are.
Prop the probability them going out the door or higher when rates go up so.
It is a it has served as a mitigate it also helps us in general with cash flow testing. So there are peripheral benefits from holding some floaters. Although income is a hasn't been one of them recently.
I would just add to further to Jim's point real quickly that if rates went down 25 basis points from here, we pay the guidance of 25 to 30 million of impact I think thats, probably close to half of that impact now given some of the floors. The Jim talked about so its asymmetric if rates go up its 25 to 30 million more income, but if they go down.
And maybe it's 15 to 20 less and then from there. It's you know even less downside.
Your next question comes from a lease Greenspan of Wells Fargo.
Hi, Thanks.
[laughter].
First.
My question would be you.
Oh, sorry, we're talking about that pipeline you said I guess, you bucketed into two different categories those waiting for clarity.
Oh.
Is there I.
Between.
Bucket and then my quick numbers question would be you called out.
Within your PR keep it isn't a quarter can you just put a number on that.
Sure I always I'll go first and then Marty I'll talk about the mortality.
Result, the.
No I don't think there is a size defense it's between those two buckets if at all because you know it management teams that other companies.
No sometimes they have a fairly big enforced block, sometimes it's relatively smaller relative that other old operations. It. So I guess, it's more sort of you know where they are in their particular situation you know it's very.
Our next case specific in terms of what's going on some people really I think we'll feel compelled that they need to do something now.
Others or others feel they can afford to wait and you know, but I, but I won't say this I think people.
I I don't think people a lot waiving any longer for higher rates [laughter] I think they realize that that's probably you know not something they should do its maybe more probably it's more just about whether capital position is relative to you know what kind of credit losses may occur over the next 12 months or so.
And at least it's Marty on the mortality item and PRT. If you look at the institutional credit rated dropped to think about 44 basis points sequentially.
And I'd say, probably about two thirds of that drop was due to this mortality phenomenon kind of good guy and the other say one third is due to some of the the funding agreement impacts we talked about so as we gave that guidance in my remarks, we're obviously not predicting future mortality benefit so kind of just assume that's just happening in this.
Quarter.
Your next question comes from the lineup Humphrey Lee of Dowling and partners.
Good morning, Thanks, taking my questions are just going back on D., the Japan and can flow reinsurance opportunities.
Can you maybe size do you tend to be the potential.
They don't tell what do you have any kind of <unk>.
I wish tolerance.
Uh huh.
And from Japan.
Humphrey high a little bit of that your second part of your question dropped out in terms of size look I think we I think our when we went into this arrangement.
Like our target was.
$500 million deposits, you know for a one year run rate.
I would say based on just a couple of weeks the sales.
That number maybe has upside so we'll see and of course there are other potential partners in Japan. This is just the first one I think once you've sort of crack the market.
And if it did you had success I think you are I think there's going to be a lot more opportunity.
How much you know there in terms of risk how much would we take well that's a good question I mean, obviously you know we don't want a whole a liability portfolio where are we you know where we're always.
Hedging the exchange rate risk, we would like to a you know but to keep it.
But I don't think we have a target pool in mind right now, but the reality is is the rest of the company is growing so fast.
You know if the Japanese business can keep up that'd be great, but it's.
Probably won't.
Our final question will come from the line of Mark Hughes of Trust Securities.
Yes. Thank you a very quickly on the independent agent channel within the retail if you are.
ER that started to come back I think there are operational challenges and making those sales are you seeing any recovery.
I do think it's coming back I think what you know if you think about what happened.
The IMO adviser you know independent <unk>, you know marketing company advisor.
Probably lost the ability to do a lot of sales because he loves to face to face. So he went through as you know this prospect pipeline and that helped him for awhile.
But I think sales have suffered a little bit you know what's the inability to.
To get face to face with customers.
So I think gives them as the market opens up and it's that's actually going slow I do think they'll recover.
There are some operational challenges, but they're not substantial I mean, one thing. We've done you know there literally are still advisors, who submit apps by paper, you know and and you know well you know just like in the rest of our lives where we've become much more virtual electric digital you know advisers have learned they need.
To become more digital too so I think you're seeing a lot of change in behavior, even among a you know these these types of advisors. So you know I don't know if that's what I'm sure. That's had a small impact in terms of you know the virtual nature of communication between us and advisors, but I think we've overcome a lot of it.
Thank you at this time I'd like to return the call to know.
For closing comments.
Great. Thanks, Laurie and thanks, everyone for joining us this morning and for your interest in a theme. If you have any follow up questions regarding anything we discussed on todays call. Please reach out to myself or Soo Lee and we look forward to speaking with everyone again next quarter.
This does conclude today's upbeat holdings second quarter 2020, <unk> earnings conference call and webcast. Please disconnect. Your lines at this time and have a wonderful day.
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