American Equity Investment Life Holding Co (AEL) 2009 Q3 法說會逐字稿

Welcome to the American Equity Investment Life Holding Company's Third Quarter 2009 Conference Call. At this time, for opening remarks and introduction, I would like to turn the call over to Julie LaFollette, Director of Investor Relations.

Good morning, and welcome to American Equity Investment Life Holding Company's conference call to discuss third quarter 2009 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com.

Presenting on today's call are Wendy Carlson, President and Chief Executive Officer, Ted Matovina --.

Ted Johnson.

Or Ted Johnson, I'm sorry. And Ron Grensteiner, President of the Life Company. 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 risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause the actual results to differ materially are discussed in detail in our most recent filings with the SEC.

An audio replay will be available on our website shortly after today's call. It is now my pleasure to introduce Wendy Carlson.

Good morning, and welcome to the call. We've got a little different group here to discuss the third quarter '09 results with you. Most unfortunately, John Matovina is home ill today and so we're missing him.

But to help answer questions, we have Ted Johnson, who is the Controller and Chief Accounting Officer, as well as Jeff Lorenzen, who's our Chief Investment Officer. So I'm sure John will be pleased to know that it takes three of us to cover his part of the comments on this call.

We have a lot of what we think is really excellent news to report this quarter, starting with the fact that we've now reached over $3 billion in sales for '09. Through October I think, we were actually at about $3.1 billion. So we are well on our way to exceed that goal by a significant measure.

As a lot of you know, this has been a big target of ours for a lot of years. So we're very thrilled to have reached it.

The nearest year we had to this was '05 with $2.8 billion. So it's been a long time in coming. But it's been an extraordinary year of sales. And Ron will be discussing that later, so a big development for us.

In addition to that, we've reported operating income for the third quarter of '09 in a record amount of $28.2 million, which is $0.47 per diluted common share. That represents very strong spread results for the quarter, which we'll talk about in a little bit.

It's a significant increase, 26% over 3Q '08 operating earnings of $22.3 million or $0.40 per diluted share. Our EPS calculations in '09 are affected by our issuance of shares in the second quarter in connection with an exchange to retire some of our convertible debt. So as you're looking at EPS, keep that in mind.

In light of the very strong sales growth during '09, as you know, we've had a real strong focus on capital management throughout the year. And we've discussed a number of steps that we've taken to support our capital on prior calls.

In the third quarter, we continued to take steps including implementing our funds with our co-insurance arrangement with Athene Life Re. We announced that on our last call. That has now been implemented. The reinsurance treaties have been finalized. And we've seeded a total of $514 million of premium to Athene.

That amount represents two different blocks of annuity premium. First of all, it represents $23.5 million of multi-year rate guaranteed business of which we are seeding 80% to Athene beginning with annuities sold in the third quarter of '09.

The larger portion is $490 million of premium on our two top selling index products. That represents 20% of premium sold in those products for the first nine months of 2009. The purpose of structuring the reinsurance in this manner was to limit the new liabilities that American Equity retained throughout '09 to $3 billion or less, to help us manage our capital through this period of very strong growth.

In addition, we announced in August, our $50 million at the market offering. This is an offering of common stock that allows us to issue stock at times and at prices we select, subject to daily volume limitations.

We have a go slow approach to this. We are seeking to be very opportunistic in how we issues shares. So far we've issued 132,000 shares at an average price of $8.26 a share. That's a total of $1.1 million in gross proceeds.

We are not in a rush to complete the offering. We're not interested in issuing stock at prices that we don't think reflects the value of the stock, and so we will wait and see as we progress with that program how the stock behaves.

The purpose of this program is to add financial flexibility to our resources right now. It's not to fill any holes left by asset impairment issues. Our plans for the proceeds from this offering are either to contribute the proceeds to the capital of our primary life subsidiary, or to buy back additional convertible debt, assuming it continues to trade at a discount.

So that covers the capital steps we took in the third quarter. We are continuing to work on a couple of items in the fourth quarter that involve, principally, our residential mortgage-backed securities.

As most of you are aware, this has been a very big issue for the Insurance industry as a whole. Downgrades by rating agencies have resulted in very significantly increased capital requirements. The rating agency actions are somewhat problematic because they reflect only the probability of a first dollar of loss and don't reflect the severity of the expected loss.

As a result of that, the capital that we're required to hold is sometimes as much as 12 times more than the projected loss in the security, so very unusual results there. And it's something that the NAIC is looking at very strongly.

With respect to American Equity's mortgage-backed securities, they are all performing. And we continue to think that it's a good asset class. However, we're going to move forward on a couple of different fronts with capital steps.

One is in looking at a Re-Remic transaction, which would help us realign ratings better to expected cash flows, and would improve the liquidity of the cash flows. Second of all, we're watching carefully what the NAIC is doing with rule changes. And actually later today, they've got a meeting to vote on a re-rating process that is expected to have a significant impact, and be helpful to us from an RBC standpoint.

If you set aside the issues relating to the ratings migration of the RMBS securities, our RBC ratio would, today, still be above 300%. It's not, because of the impact of the additional capital required by those securities. After the NAIC rule changes, and after the Re-Remic that we are working on, we would expect, and hope, that the RBC percentage at year-end would be above 300%.

Turning now to earnings, as I mentioned very strong operating earnings for the quarter that's been driven by spreads starting with net investment income for the quarter of $241.5 million. That represents an improvement in yield. It was 6.32% for the first nine months of '09, compared to 6.18% for the comparable period in '08.

As a standalone quarter, 3Q '09 was 6.38%, including some non recurring income, $2.4 million of fee income included in the quarter related to a prepayment principally of one of our corporate bonds, and a couple of other smaller items. If you exclude the non recurring income from our investment income, the yield for the quarter would have been at 6.31%.

In addition to seeing improving yields, we also have continued to see our cost of money decline. It was at 3.25% for the quarter. And that reflects continued low cost of hedging, low cost of purchasing options to fund the index credits and on our Index business.

In addition to that, we continue to see a very high allocation of premium by policy holders to the fixed rate strategy, which helps us with our cost of money and has resulted in continued improvement. For the nine months, the cost of money was at 3.29%. That compares to 3.45% for the same period last year.

So the combination of improving yield, and declining costs, resulted in an all-time high spread for the quarter of 3.13% -- 3.03% for the nine months. So we're very, very pleased to see spreads at that level, particularly in light of some of the financial challenges affecting the economy generally.

Looking to new purchases made during the third quarter of '09, it included $1.3 billion of securities including $775 million of agency securities, $445 million of high grade corporate, and $102 million in taxable municipals, which is a new asset class for us. The average combined yield on those securities was 6.28%.

In addition, we made new commercial mortgage loans in a total amount of $46.7 million. And the interest rate on those loans is 7.02%.

As I'm sure you'll recall, we've been experiencing a very high level of calls in our agency portfolio during the course of this year. That's slowed down somewhat in the third quarter of '09 with $447 million of calls. That compares to over $2 billion of calls in the second quarter of '09, so a significant slowing on that.

The yield on the called bonds during the third quarter was 5.91% compared to 6.23% last quarter. So also lower yielding securities being called.

As we've watched corporate credit spreads tighten, and yields come down, during the quarter, we've been carefully thinking about spread management and rate adjustments. We did announce to the field, rate reductions affecting most of our products. And those are effective on November 4 -- or were effective on November 4.

Turning to our commercial mortgages, we've got $2.4 billion of commercial mortgages as of September 30, 2009. That represents 16.4% of American Equity's invested assets. That's down a little bit from where it was at the end of the year.

We presently have a total of 1,005 loans at an average loan size of $2.4 million. So it's a big block of mortgages spread across a lot of industries and widely diversified on a geographic basis.

We now have five of those 1,005 loans in foreclosure. We have two properties that we own as REO properties, as a result of foreclosure actions. We have a handful of loans that we have put in interest only status now for a limited period of time.

As a result of those actions, we've now recognized in the third quarter, $5.5 million of impairment losses. Those relate specifically to the five loans that are in foreclosure. We had $1 million of loan loss allowance that we recognized last quarter, and that related to a loan which is delinquent but not in foreclosure.

We believe that these issues are small relative to the total size of the commercial mortgage portfolio. The core characteristics of that portfolio remain very strong, including the loan to value ratios, cash equity recourse to the borrowers, etcetera.

The other asset class that I want to address specifically is the RMBS securities. We had $2.6 billion at the end of September, representing about 18% of the overall portfolio. As I commented earlier, those are all performing with no missed payments.

However as a result of the downgrades, and the projection of future losses in those securities, we were required to recognize some other than temporary impairment losses. That comes to a net amount of $26.1 million due to those projected loss estimates and downgrades.

As I commented earlier, that our RMBS portfolio, and the RBC calculations, will be impacted by the NAIC rule changes. And we should have information very soon about that.

A couple of other comments on the Re-Remic that we're looking at, that would involve a block of Alt-A and Prime securities that have been reduced to a NAIC 4, 5 or 6 rating category as a result of the downgrades. It's been interesting to us as we've analyzed Re-Remic possibilities that as you look to a block of securities to rerate through that process, we think that over 60% of the cash flows from those securities would be restored to a AAA status. And that the ratings would much better reflect the actual credit quality of those securities.

Re-Remics have been a big topic in the industry. There are still some statutory accounting uncertainties around them. But with the end of the year so close at hand, we think it's important to move forward on that front as well as continuing to monitor what's happening with the NAIC.

Our watch list totals appear on the financial supplement, which was published. It's not much changed from the second quarter of '09. There is a slightly more in terms of book value reflected in the watch list on an aggregate basis, the total watch list securities increased to $682 million at the end of September compared to $643 at the end of June.

However, the unrealized decline -- unrealized loss, the decline in value is actually smaller in the third quarter at $132 million compared to $159 million at the end of June. And the great majority of that, $111 million, is in the RMBS portfolio and reflects the issues that I've been speaking to.

Other significant income statement items, DAC and deferred sales inducements, the amortization there followed a normal pattern for the quarter with no unlocking. We've commented previously that we're back to a normal pattern in our DAC amortization after the unlocking that occurred in the fourth quarter of '08 and the reset of account balances that occurred in connection with that.

Operating expenses, other operating costs and expenses, declined to $14 million compared to a little over $16 million at the end of the second quarter. We had some one-time items last quarter that caused it to be somewhat higher than we would ordinarily expect, so it's returned to what I think of as a more normalized level.

For GAAP purposes, we had a net loss of $3 million, and that's driven by a couple of things. I've spoken to the OTTI impairments as they related to the RMBS securities. There was also some OTTI recognized in the corporate bonds, and I've spoken to the impairment loss in the commercial mortgages. That was a gross amount of just over $50 million after we make adjustments for DAC and tax and offset capital gains earned during the quarter. That brings the net effect of those impairments to $11.5 million.

The bigger item this quarter was our FAS 133 adjustment of $19.7 million. That's being driven by the discount rate that's used to calculate reserves. Some of you may recall that in the first quarter of '08, we were required to and did adopt FAS 157, which resulted in a change in the rate that's used to calculate reserves. We previously used a risk-free rate but now use a risk-adjusted rate that would reflect credit-related issues.

As a result of that, the discount rate we use from quarter to quarter changes as corporate credit spreads change. With the tightening of the corporate credit spreads in the third quarter of '09, we saw the rate being used decline. That means the value of reserves increases, and that difference flows through our income statement as an expense.

So now FAS 157 is causing the overall effect of FAS 133 to be even more volatile than it was before, and we think it underscores all of the reasons that we focus on operating income as opposed to the impact of GAAP with the FAS 133 issues that flow through it.

Book value for the quarter was at $13.03 including other comprehensive income. If you exclude the other comprehensive income, it was $12.79 a share. We are seeing in other comprehensive income now for the first time, and that reflects that fact that we have just a very small, relatively speaking, unrealized loss in our available-for-sale securities.

We previously put up a deferred tax allowance that flowed through our income statement and depressed earnings and stockholders' equity. Now that we're seeing a gain to the portfolio we've been able to reverse that tax allowance.

That happened in the second quarter, and now with the shrinking of the unrealized loss in the portfolio it turns our other comprehensive loss into other comprehensive income.

The last thing I'll comment on before I turn it over to Ron to talk about sales and production is just some of the changes you'll see in our balance sheet related to our reinsurance transaction list, a scene you'll see included within our invested assets, a line item for trading securities. That reflects the securities in the funds withheld trust that we hold as collateral for that coinsurance.

You will see an increase in our coinsurance deposits, which reflects that transaction, and in liabilities you'll see a new line item for our funds withheld reinsurance liability, which reflects that same item. So those are new things this quarter, and we've kept Ted and his department very busy all year with these kinds of changes.

So with that, I'll turn it over to Ron.

Thank you, Wendy. Good morning, everyone. 2009 will certainly be a year of broken records from a sales standpoint. I can honestly say that in my 24-years in the insurance business I don't think I've every witnessed a year quite like this.

The demand for our products is unprecedented as we see a highly volatile stock market and, of course, low bank rates. And this drives consumers to our products, and it's really been a year of getting back to the basics, the basics of tax deferral, guaranteed principal protection, guaranteed interest, guaranteed income.

And then you couple this with limited sales capacity from many of our competitors, all creating this perfect setting for American Equity. And as a result and as Wendy reported, we hit that $3 billion mark for the first time in company history. It was a great day for us, and the third quarter sales were $980 million, a 71% increase from the third quarter of 2008, which was $572 million.

To kind of give you an idea of some of those record-breaking numbers, in -- excuse me. Prior to 2009, our record production month was $297 million. That was way back in 2005. If you look at 2009, 6 out of the 9 months we were above $300 million, and our new record month is $409 million, which we set back in June.

As far as new agents, all year last year in 2008, we hired 6,278 agents. And so far through the third quarter of '09 we've already hired 7,811. That's always the great bellwether, agents' recruitment is up, which means that sales will go up as well.

Gold Eagle membership, a Gold Eagle member agent is a producer that sends us at least $1 million in annuity premium over the course of a year. Last year, in 2008, we had 566 Gold Eagle members. Through September 30th, we're already at 672 and we're on track to get awfully close to 900 Gold Eagle members before the year is up.

Also from a marketing company standpoint, through September last year, we had six NMOs, or marketing companies, write in excess of $100 million with us through June. So far through June this year, we're already at 15.

Finally, another record of course is pending and, as you all know, that's kind of how we gauge activity in future sales. Our record pending was just over 6,000 pending applications, and we started way back at 1,800 back in January. Previously, the record was just over 4,400 back in 2005.

Well, let's talk a little bit about today. Those are some unbelievable statistics, and so where are we headed from here? Pending as of now is around 3,700. It has moderated. To put this into perspective, we did not cross 3,000 pending apps for all of 2008. We're currently at a monthly run rate of about $300 million which is awfully strong, of course. It was a little bit less than that in September.

We also have had some increased sales from the multi-year guaranteed products, as Wendy referenced a little bit earlier. This gives us a chance to attract some additional types of business. And, of course, it sends a good strong signal to our producers that American Equity's open for business.

And as I mentioned, contracting is up this year and it is up now again. It's beginning to increase. October was actually our second biggest recruiting month for the year, which was right behind May. May, we had a big influx of producers, and now in October was our second biggest month.

And not by much, October was real close to being our biggest recruiting month for the year. So, that is a very strong indicator that sales are still strong, or will continue to be strong, for American Equity.

This is also a very appropriate time, I think, to say how proud we are of all of our American Equity employees. We've gone through this unprecedented time in growth and sales, and we're so proud that our people did not miss a beat in providing quality service.

You know, when you go from 1,800 pending apps to 6,000 pending apps in a very short period of time and do it really without hiring additional staff, it is an outstanding achievement and it goes through the whole company.

It starts with agency contracting. They've got to get the agents hired. And then it goes through marketing, and then it gets to supplies. You've to have supplies to write the apps. Then it goes it new business, and then it goes to commissions, and then it goes to service, and then all those other departments that service those departments. It was just an unbelievable effort, and I can't say how proud we are of those folks.

And, you know, it wasn't necessarily easy. They came early and stayed late. Some folks came in on Saturdays to keep up, but the point I really want to make is the culture here at American Equity is so different, and our people care about American Equity and our reputation for good service. And, quite frankly, that's a culture that you just can't buy anywhere. And we're so proud of all of our folks here.

As 2010 approaches, I believe the demand for our products will continue to be very strong. Our competitors will emerge at some point. Product development by our competitors has been relatively quiet so far.

As for ourselves, we have some ideas, too premature to talk about this morning, but we find in visiting with our field that we already have the sweet spot really covered for product portfolio, and the sweet spot is everybody is looking for premium bonuses. We've got that. And everybody's looking for a quality lifetime benefit rider or a guaranteed income rider, and we've got that. We probably have one of the better in the business.

And so, our anticipation is, is that we've attracted a lot of new agents this year due to some of our competitors' missteps. Our anticipation is we've given them such a wonderful experience of working with our people here at American Equity that they won't want to go back. And that is certainly our -- we're certainly not going to encourage them to go back.

We also just completed a swing of visiting with our top 15 marketing companies. We typically do this once or twice a year where we get out into the field, call on our marketing companies, kind of talk about 2009, what are their plans for 2010.

This is another thing that I think is extremely unique with American Equity that we go out into the field and talk to our top partners. And we do more than talk. We just do a lot of listening too to see what's on their minds.

So, that's -- we've seen some great feedback from those visits. Everybody is very content with American Equity and has given us commitments that they're going to be in our corner again next year.

Finally, we had a very successful Chairman's Club conference. We had that back in September. We spent some time with our best producers and our best marketing companies. From the producers' standpoint, to be there they had to have produced at least $7 million in annuity premium in a 12-month period, which is quite a sum, and we had over 20 qualify. So, that was a very gratifying experience to have all those people there.

We had a great time with those folks as they really recommitted to us that they were going to be in our corner, and we recommitted to them that we were going to be there for them in 2010, just as we were in 2009. So, we had a -- it was a very uplifting time that we've had with those folks and a good opportunity to strengthen and reinforce those relationships.

So, we're very bullish on 2010 and anticipate that our products are going continue to be strong. And so with that, I'm going to turn the conference back over to Wendy.

I will conclude by giving you your 151A update for the quarter. There's not a whole lot to report at this point. There's been no indication yet from the SEC how they intend to respond to the remand of the rule by the Court of Appeals for the D.C. circuit.

We have held several meetings now with the SEC. The coalition, including American Equity, attended a meeting in September involving the General Counsel's Office in the Investment Management division of the SEC.

There have been a couple of meetings with the commissioners, and I know the NAIC has another -- a co-petitioner in the litigation has also held separate meetings with the SEC with the goal of finding out what happens next and really what the SEC's plans are at this point to address the remand.

What they have told us is that they take very seriously the obligation to conduct the study that was found lacking in the court ruling, and that is a study referred to as a 2(b) analysis that deals with the effects of a proposed rule on efficiency, competition and capital formation. They've said that that's an important obligation to them that they take seriously.

They've also said that they will be reasonable in looking at what the effective date of the rule should be if the rule is finalized. Today, the effective date would be January of 2011.

That reflects the timing needed not only by industry but by the SEC and FINRA to get all of the tools in place that are needed if the SEC is going to begin to regulate these products along with the state insurance regulators.

Because of the timing that's required, there have been a lot of questions raised about whether that January 2011 is realistic and whether it will hold. The only information we've received so far is that the SEC says it will be reasonable on the timing.

There is a motion pending back in the Court of Appeals. The only information we've received so far is that the SEC says it will be reasonable on the timing. There is a motion pending back in the Court of Appeals that is requesting the court to specifically address the issue of the effective date.

We've been opposing the rule, not only through litigation, but through legislation. And as we've talked about in prior calls, there are bills pending in both the House and the Senate that would have the effect of overturning Rule 151A. We continue to work, and we're very proud of the American Equity team that's been working on developing co-sponsors for the bill and very successfully, I might add, we now have 48 co-sponsors in the House and another five Congressmen who've given verbal commitments that they intend to join the bill. There are eight co-sponsors in the Senate, including, most recently, Senator Leahy of Vermont, which was an important development and the momentum among the agents and marketers to continue to reach out to their Congressmen is really impressive and we'll continue to work on that.

The next event on that front will be a call-in day on November 10th, where agents around the country and marketing organizations will be calling into their own representatives to urge them to sign onto the legislation and help defeat Rule 151A.

We know that we have worked very, very hard to oppose the rule, but that if the rule becomes effective, we need to be prepared for change. As we've talked about on prior calls, we have formed a new life subsidiary, Eagle Life, that would be the subsidiary through which we would sell registered product. Eagle Life is now licensed in 30 states and so we continue to work on expanding the licensing of Eagle so that we are ready to go. We also filed a registration statement for our first registered product through Eagle that was filed last June. We just, within the last two weeks, received our initial comments back from the SEC. We understand that that registration statement was very carefully scrutinized in light of the fact that this is the first registration statement filed for an indexed product, post Rule 151A. And we will respond to the comments and are hopeful that we'll have an effective registration statement either by December 31 of this year or very shortly after that.

We -- once that work is completed, we are still working on getting the broker-dealer distribution channel in place and that will continue to take some more time and effort to make that change.

And I will conclude with the comment that there's nothing new to report, either on the wells or the litigation front, so all has been quiet on those fronts.

And with that, I'll turn it over for questions.

(Operator Instructions).

Your first question comes from the line of Randy Binner of FBR Capital Markets. Please proceed.

Hi. Thanks. Wendy, you did a good job of preempting a lot of our favorite questions, so I will --.

We always try, Randy.

I will -- I just want to understand the economics of the reinsurance deal. On a go-forward basis, which is really just for the rest of the year, you give away about 20% of the economics on the top indexed annuity products and then 80% on the multi-year guarantee. And so when we think about modeling it, should we just -- is that the right way to think about it financially? That those economics are going to the reinsurer?

I think you should focus on the business retained, which will be -- we estimate approximately $3 billion and we will be earning our spread on that.

So production in excess of the $3 billion, you're right, we would not be earning our spread on that.

Okay. So just think of it as kind of stopping at $3 billion in our model and then anything over is going to effectively flow to the remaining share.

Correct.

Okay. That's actually -- that's more simple.

And then the potential extension of that agreement, I guess, would be then, depending on whatever impact you see from the NAIC on the RMBS issue today, as well as the potential outcome of the Re-Remic, that's the right way of thinking about that, right?

Actually, the reinsurance is not meant to address RMBS issues or the related capital issues. That is an industry wide thing.

And so we will look exclusively to the NAIC and Re-Remic to address that.

What would be a driver of looking to coinsurers in the future would be levels of production.

And so if they continue very, very strong, and you heard Ron's comments on that, then we, once again, would be looking to manage our capital very carefully and would be considering reinsurance as an alternative.

Okay. Understood. So I guess let me try this question. With what -- what could potentially be the sales capacity goal for 2010?

Oh, gosh, that's -- I wouldn't put Ron in the position of trying to predict what that is. In terms of what the demand might be, when we did our modeling earlier this year, we did our modeling with the goal of being able to write $3 billion a year with, I believe, it was a 10% increase for the next two years and remain above 300%. So with the steps that we've put into place this year and based on our modeling earlier this year and setting aside the RMBS issues, we would expect to be able to write up to the $3 billion level and with a modest increase based on our current capital capacity.

Okay. But you are run rating kind of closer to $300 million a quarter right now?

You mean a month?

I'm sorry, a month, yes.

Yes, we are.

Okay.

That is -- that's all I have right now. I'll re-queue with some other housekeeping [questions]. Thank you.

Yes.

Your next question comes from the line of Steven Schwartz of Raymond James and Associates. Please proceed.

Hey, good morning, everybody.

Hey Steve.

And congratulations on the $3 billion.

Thanks.

I know you've been working hard on that.

I've got a bunch, I'll just ask a few and then get back. I'll target these towards Ron. Ron, can you maybe talk about the crediting changes that you've made? I'm always interested in particular hearing about the 100% participation with the cap, where that's going.

Do you -- would you happen to know year-to-date what percentage of the production has come from the Golden Eagle members? And simply because I have to ask an SEC 151A question, I'm trying to figure out what is going on with the NMOs themselves? How are they reacting, if they're reacting at all, or preparing?

Okay. Good morning, Steven.

Good morning.

The rates that we've adjusted, this is the first time that we've actually adjusted rates, I think, since February. And today we're looking at annual point-to-point caps at 6.5% for most of our products. They actually went from 6.5% down to 6%, excuse me. And the monthly point-to-point caps went mostly from probably around 280 down to 260 and the 240 range for the bulk of our products. So they weren't real significant changes. The fixed values dropped from about 335 down to 310, some products down to 290. So those were kind of the changes that we made.

When we look at those changes, we still think that we're in the hunt and as far as the competition goes, actually, many of our competitors have slightly lower rates than we do, so we think we're doing okay there.

I think, was the second question, how much is going into the strategies. Was that the question?

No, no, the question was if you had a sense of what percentage of your -- of your production is coming from Golden Eagles. It's always been -- it's been my thought, since SEC 151A developed that these were the guys who most certainly would go get registered, if it came down to that. So I'm interested in if you happen to know what percentage of production comes from the Golden Eagle members?

Well, it is a high percentage, Steven. Its north of 50%, probably pretty close to 60% of our business comes from the Golden Eagle agents. And as far as being securities licensed, it really is a mixed bag, when we look at our producers across the board on the -- some surveys that we've done informally and formally. We're finding that probably more than 30, but less than 40% of them are actually securities licensed at 2006 time.

Yes, but my point being, though, if a guy's doing that much business, he's going to get securitized. He's going to go get securities licensed if he needs to be.

Or sell other products.

Yes, exactly. There are some of those Golden Eagle agents, Steven, that have perhaps in their former life, sold registered products or securities, and quite frankly, have told me they're not going to go back to that life again. If we lose the 151A battle, I think there will be a good chunk of them that just say, the heck with it, we're going to sell traditional fixed products, we're going to sell lifetime benefit riders, we're going to get back to life insurance. After all, that's what we all sold before indexed annuities were even invented. So there will be some that do it and there will be some that don't.

Okay. And then just a follow-up on that then. What are the NMOs doing, if anything?

There's, I think, Steven, there are a lot of NMOs that are fence sitters right now. We've talked to a good chunk of them that -- what are their plans for their agents and going forward on 151A. There are some that already own broker dealers. There are some that had registered investment advisors that they've set up. Some of them already have alliances with different broker-dealers. And some, quite frankly, have the same mind set as some of those agents. They're just going to not mess with it and let it go.

But there's, at this point, I'd say there's more fence sitters than anything as they kind of wait to see what happens with 151A.

Okay. Thanks. I'll get back in the queue.

Your next question comes from the line of Paul Sarran of FPK. Please proceed.

Hi, good morning.

Hi, Paul.

I just had two questions. The first one on the new money yield, 628, on fixed income securities and 702 on commercial -- new commercial mortgage loans. In particular, the fixed income securities seems like a pretty solid result, given spread tightening is kind of evidenced in your own portfolio. I was hoping you could tell us what -- give us some color on what you're investing in as far as ratings or sectors?

My second question was the operating expenses in the quarter were somewhat lower than they've been the past couple of quarters. I would have expected them to go up, just with the higher volume going through the business. So any color you can give on that would be helpful as well.

This is Jeff Lorenzen, the CIO.

One of the things we -- getting specifically to the investment side, we've tried to bring down the overall risk in the portfolio by creating greater diversification. And part of that strategy has been to monitor all elements of risk in the portfolio.

The addition of securities this quarter came predominantly through agency securities, corporate securities. There we're focused on, obviously, investment grade and higher, BBB and higher, is the focus. And then on taxable municipal securities, with the wide issuance of Build America bonds and you look at the risk relative to corporate securities and downgrades, taxable munis are a great place to be investing. We've been active in that market for some time.

We've put on about 100 million in the third quarter. Even though yields have come down, we've continued to be able to still find investments that have been able to generate yields close to the targets where we need to be. And typically those have been in the 20-year part of the curve for our taxable municipals. The agencies vary between accruals as well as coupons. And then the corporates are across all broad industries in terms of our credit exposure there.

Does that help?

That -- yes, that does help.

If -- even with the mix of the agency, you're still getting pretty solid yields. Do you know about the average for the corporates you've been buying?

It's around -- for the third quarter, it's been around 660.

Okay. Okay. That's helpful. Yes.

And one of the things that's part of our strategy, we've seen a fairly volatile long end, or even the ten-year part of the curve has been coming up and down and we were at the point where we can be somewhat flexible in the timing of when we are purchasing. And we happen to be buying it at good times in the market. When yields come up, which we're adding more paper than when yields come down, so on a relative basis, I would say that our spreads are attractive, but we're also being able to appropriately enter the market at good times on a relative basis.

Okay. Are you generally going out longer than the current portfolio?

No, we've been able to maintain our duration. If you look at our duration historically, we're still maintaining that duration. The idea is to bring down some of the, what they call, the duration drift in the portfolio, of how much the portfolio might extend or contract with the change in interest rates. And we've also been able to bring that down with a tighter management on the agency securities.

Okay. That's very helpful.

The operating expenses?

This is Ted Johnson, I'm the Controller. In regards to the operating expenses, we assume at least a one-time expense in the prior quarter, related to a retirement agreement package that was put in place for our Chairman, Dave Noble, and that was approximately, a $1.2 million expense that we -- one-time expense that was incurred in the prior quarter. So that is part of the reason for the decrease.

We've also seen a decrease in just general legal expenses for this quarter also.

Okay. And then since that answer just reminded me, did you give an update on the lawsuits in California?

Only to the extent that there's nothing new to report. The federal case that's pending in Los Angeles is really dormant, completely, and the case in San Francisco has a trial date next year and so there is some procedural steps in discovery going on there, but nothing of note.

Okay. Thanks. That's all I have.

Your next question comes from the line of Bill Dezellem of Tieton Capital Management. Please proceed.

Thank you. We have a couple of questions. First of all, the $2.4 million of extra income that you received, was that included or excluded from the operating income number of $0.47?

It's included.

And so therefore, if -- given that that's one-time, if we were to pull that out, that would reduce the $0.47, correct?

Yes, it would, although I can't tell you for sure by how much.

Okay. Not a problem.

And the $5.5 million impairment on the five mortgages that are in foreclosure, what sort of a percentage reduction in there, in the loan value, does that represent? Or the impairment was pushed out of loan value?

Hang on a minute, Bill, we'll see if we can find that information.

No problem.

I don't know that we have that specific information, but we can get that to you.

Okay. I'll circle back later then for that.

The next question is relative to the commercial mortgages, how would you characterize loan demand at this point?

I think it's still fairly strong. We're -- our underwriting standards are typically high -- are -- have remained high, so it becomes more challenging. But there's still ample opportunities out there in that market.

And are you finding any change in loan demand by the, really, the qualified buyers?

I think the qualified buyers are still -- are still out there. And obviously as we go through our underwriting, that's one of the screens we go through. We're not focused on the non-qualified buyers. We have our screening process we go through. But we're seeing -- we're continuing to see opportunities from quality borrowers that we feel comfortable and that underwriting standards that we've historically used that are appropriate from a risk versus return perspective for the company.

Great. Thank you. And then my last question here is going to expose my ignorance. You had mentioned in the opening remarks, Wendy, that you had normal amortization. And -- of the DAC and policy acquisition costs. So I was looking in the -- or on the press release, and there's actually a negative -- we're showing a negative number. So a negative expense, am I reading that incorrectly?

I think what you're looking at is the impact of the FAS 133 adjustment to that. If you look at operating income, you'll see that the expense for both amortization of DAC and amortization of deferred sales inducements increased roughly a couple of million dollars, each of them from the prior quarter, which is the trend that we expect. And when you see unusual negative items, that's typically the DAC adjustments that we're making, that's FAS 133 adjustments that we're making to those line items.

And also in the reconciliation, that shows that the realized -- in the realized losses column, also adjustments to both the DAC and the deferred sale inducements. So help me understand why realized gain and losses impact that also? And I apologize for my ongoing ignorance here.

It's a very complicated question that has to do with the rules around DAC and I'm going to let Ted field that.

On an as reported basis, or on a GAAP basis, when you're doing your DAC amortization pattern, the DAC model does not consider realized gains and losses in it. So when you actually incur realized gains and losses, you have to flow those through the DAC model and the effect of that.

So in a period of time where, on a GAAP basis, you're incurring realized losses, that is going to have an effect -- decreasing DAC amortization. And so when we're doing our operating income here, we're reversing the effect of realized loss on the DAC amortization pattern.

That's helpful. Thank you.

You have a follow-up question from the line of Randy Binner of FBR Capital Markets. Please proceed.

Hey, thanks. Most of my questions have been answered. The only thing I'm trying to follow-up on, is there any quantification you can provide on where RBC is currently or more prospectively, what the rough impact on RBC might be from either the NAIC potential move on RMBS or from a potential Re-Remic?

Yes, we've been doing those calculations and understand this is all projected and based upon estimates. If you go back to June 30, it was the RBC ratio would have been at around 250%, as you factor in earnings for the rest of the year as well as contribution from line of credit that would bring it up to the 260 level.

A Re-Remic would, again, on a projected and estimated basis, would bring it up to around 305%. So a very significant jump there related to Re-Remic and the NAIC proposal, as best we understand it currently, would take it up above 315%.

So I think you can tell from those numbers that the RMBS issues are very, very significant and they're not just affecting us that way, they're affecting all life companies that way.

No, yes, understood. Any -- and just to be clear, the Re-Remic move from 260% to 305%, that's a -- that was just for the Re-Remic and the NAIC was from 260% all the way to 315%? Or was the NAIC incremental?

It's all incremental?

I mean in that -- like if I just took the NAIC thing, that would go all the way to 315% just by itself? Or do I need to get -- do I need the Re-Remic and the NAIC thing to get to 315%?

You need both of them.

Got it. So the Re-Remic's kind of the big one and the NAIC adds a little bit on top.

Correct. That's -- as we've looked at what the NAIC is contemplating, that was one of the reasons that we felt it was important to move forward with the Re-Remic as well.

So I mean, what -- I mean, we've heard feedback from a lot of other companies, not a lot, a few other companies, that have looked at Re-Remics that they're not totally comfortable with how the regulators and the rating agencies will react to that structure and the accounting. And I know you kind of referenced that that is a risk. But I mean, what are the main issues in there? And what would need to happen to kind of get them more comfortable? Particularly in regard to AM Best?

Yes. I -- my impression of AM Best is that they're monitoring this and that they'll sort of follow along with what the regulators decide the accounting treatment is. That's where the uncertainty is and it has to do with whether there's a mark-to-market impact for statutory purposes when you create this Re-Remic trust and move a certain amount of those RMBS securities over into this new trust. What's unclear is whether you recognize the mark-to-market impairment for statutory purposes on the whole pool of assets, on none of the assets or on some piece of it if you should sell off a 10% or 15% portion of that Re-Remic.

There's one school of thought out there that if you sell a 15% portion, that that creates a true sale for legal and accounting purposes, you would recognize the loss on the securities that were sold, but recognize no loss on the securities that were retained.

That notion seems to be getting some traction, particularly with the New York Department and some of the others, the other regulators who are talking about this, and so that may be the outcome.

We do know of other life companies in other states that have done a Re-Remic type transaction without selling anything and have been able, in their states, to avoid any loss recognition on the Re-Remic structure. So there's a whole variety of scenarios that are out there right now and we're watching that very closely, but because it does have such a big impact, as I said, we felt it was important to move forward, even before some of these things were completely worked out. Because with year-end close at hand, we would lose the time that we need to put this in place if we waited.

Now, what -- that's very helpful. What kind of scenario for Re-Remic is your -- is the -- is your scenario analysis based on? The 45% benefit to RBC? Is that based on selling of securities or not selling the securities?

It's based on not selling the securities. But it has -- the RBC impact is positive under any of the scenarios. It's just not as positive if there's greater loss recognition.

And what is stat cap at the end of the quarter?

I'm sorry?

Statutory capital at the end of the quarter, Ted, do you have the --? Hang on just a second. We got it.

It's $1.73 billion.

$1.73 billion. At 3Q '09.

Right.

Okay. And will you be roughly 260 organically, let's say? And then we have to kind of factor in the other drivers.

That's right, right?

I'm not sure what you're speaking to, of --?

When you say -- I mean, the -- your earnings would have taken the RBC to roughly 260%. 260% at 9/30. And then the rest of it is kind of RMBS related. To manage the 300.

Right.

But to put it another way, the 260% includes the previously announced items related to accessing the revolver, the Hannover Reinsurance deal, the commission restructuring?

It does.

Excellent.

Thank you very much. I appreciate it.

Thank you.

You have a follow-up question from the line of Steven Schwartz with Raymond James and Associates. Please proceed.

Hi, everybody. I just want to follow-up that line of thought. Just kind of thinking about this statutory capital of, call it, $1.1 billion, let's assume you were still at 250 for this quarter, nothing changed, and we'll get to maybe what changed. That would imply -- require capital at the control level, 215, two times that would be 429. So is that -- so that's where you would be, the required capital, 429.

Now you had a --

I'm not sure that's right, Steven.

Schwartz. Well, it's -- okay, fair enough.

But how -- okay, let's do it this way then, in generalities. How do we think about the effect of the substantial increase in the NAIC Class 6 asset? I'm assuming that's all or nearly all RMBS that's been downgraded, as you pointed out, based on a corporate bond default model?

Correct.

It just strikes me, that does not leave you in a good place, Wendy, unless you can get this stuff done.

Yes, but the NAIC is taking action. We understand they're looking separately at the issue of the NAIC 6s, because it doesn't make any sense to both mark those to the market and then put up 60% capital on the mark down value.

So they're looking at that.

Steven, the securities are performing.

Yes.

The first loss in these things does not expect to happen on average until 2015. So even though it has an effect on our RBC ratio that we don't like, that's not a big line in the sand that's going to automatically create problems for us.

It is an industry issue and so I think we're reasonably confident of two things. One, that there will be relief, both through the NAIC and that a Re-Remic process will be helpful in terms of managing those ratios. But even if those things were not to come about, the level of the playing field has changed now from an industry standpoint. So I would not envision very dramatic rating agency actions based upon these RBC ratios that are being driven by some of these issues around RMBS securities.

Okay. That's what I really wanted to go with. Because the R -- as you pointed out, the Class 6 treatment is completely nuts. And in fact, you said 60%. I think it's a, if you want to be at a 300 RBC, it's actually 90%, is it not?

I think that's right.

So that's just nuts. You write it down to market and then you've got to basically write it all off for capital purposes. So that makes no sense whatsoever.

But, yes, what I really wanted to hear was kind of your sense about the rating agencies, and particularly AM Best and what they thought about all this, whether they thought that the calculations were as nuts as I think the rest of us do.

I would never try to speak for them, but they're certainly cognizant of it and we've had an opportunity to discuss it with them and we haven't gotten any indication from them that they're going to take some kind of drastic action based upon this.

Great. That's what I wanted to hear.

At this time, there are no further questions. I would like to turn the call over to Julie LaFollette for closing remarks.

Thank you for interest in American Equity and for participating in today's call. If you have any follow-up questions, please feel free to contact us.

Thank you for joining today's conference. This concludes the presentation. You may now disconnect. Good day.