American Equity Investment Life Holding Co (AEL) 2013 Q1 法說會逐字稿

Welcome to American Equity Investment Life Holding Company's first-quarter 2013 conference call. At this time, for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Director of Investor Relations. Please proceed.

Good morning, and welcome to American Equity Investment Life Holding Company's conference call to discuss first quarter 2013 earnings. Our earnings release and financial supplement can be found on our website at www.American-Equity.com. Presenting on today's call are John Matovina, Chief Executive Officer; Ted Johnson, Chief Financial Officer; 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 John Matovina.

Thank you, Julie, and good morning, everyone. Thank you for joining us this morning. It seems like just yesterday we were doing fourth-quarter call, and in fact the first quarter I don't -- at the time we did that call, we were pretty much halfway through the first quarter, had a pretty good feel for perhaps how things were going to turn out, and they did turn out, I think, pretty much as we expected. Probably the only new thing that happened the second half of the quarter was our decision to call in some convertible notes, which were indicated in the press release, and I think Ted will talk about in his remarks.

So, for the quarter, operating earnings were $33.5 million. That is $0.49 a diluted share, up from $29.8 million in the first quarter a year ago. Results for us continue to be held back by the low interest rate environment, as we commented about in the press release, and in the last call we had. Due to the high cash balances that we are holding from calls of government agencies. And as we had indicated last quarter and in the press release, we did make some significant progress this quarter, in putting some of that cash to work. That was aided by the fact that we didn't have much in the way of new calls in the quarter. And so, that progressed, as expected.

However, as we've commented in the release and in the last call, second quarter, we are likely to have an interruption of that progress because we have almost $700 million of bonds that have already been called, that does end the call exposure, but that level of incremental cash is going to slow down the progress of reducing the overall balance. Our sales for the quarter were satisfactory at $930 million, and contributed to a 3% increase in our assets under management. The momentum in sales began accelerating in March, and it's looking to us like second-quarter sales will surpass $1 billion and Ron will -- in his remarks -- comment about the sales results and the competitive environment, give you little more background as to why we have some confidence that $1 billion level will be yet in Q2. And with that, I'll turn the call over to Ted Johnson to talk about financial results.

Thank you, John. Investment spread for the first quarter was 2.68%, and total invested assets at March 31 were $29.2 billion, $26.6 billion on an amortized cost basis. Invested assets will grow by an additional $285 million as we invest the temporary cash balance held at the end of the quarter. This spread result of 2.68% was 9 basis points more than the previous quarter's spread of 2.59%. The average cash and other short-term investment balance during the first quarter was $1.8 billion, compared to $2.7 billion during the fourth quarter of 2012. The yield on these instruments in the first quarter was 33 basis points, compared to 32 basis points in the fourth quarter. Partially offsetting the cost of liquidity was 7.5 basis points from prepayment income on commercial real estate mortgages and consent fees on bonds. In addition, we had three basis points of benefit from over hedging in the first quarter. In comparison, we had 11 basis points of prepayment income and 3 basis points of benefit from over hedging in the previous quarter.

The cost of money declined to 2.33% in the first quarter, from 2.44% in the fourth quarter. This decline reflects management's actions to maintain spreads by adjusting rates to policy holders. We will make further reductions in policyholder rates as necessary, to restore our investment spread to the 3% target. We have approximately 60 basis points of room to reduce fixed rates and rates on indexed annuity policies before minimum guarantees would cause spread compression. You can see the disclosure of this in the financial supplement on pages 10 and 11.

During the first quarter, we purchased $2.3 billion of new of new fixed-income securities at an average yield of 3.48%, and we funded $105 million of new commercial mortgage loans at an average yield of 4.32%. $1.3 billion of the security purchases were predominately investment-grade corporate bonds, with an average yield of 3.45%. We also purchased $289 million of commercial mortgage-backed securities, with an average yield of 3.67%, and $345 million of government agency bonds, with an average yield of 3.12%. During the first quarter, $250 million of government agency securities were called. These calls include $200 million that had a book yield of 1.08%, that were included in the year-end short-term investment amount.

Our government agency bond call exposure for the remainder of 2013 includes $678 million of securities, with book yields and coupon rates of 4% or higher, that were called in April. An $18 million security with a book yield of 0.96% that was called in April, and $509 million of securities with a book yield of 0.75%, that are expected to be called in July, based upon current interest rates. The securities expected to be called in July were purchased as substitutes for cash investments, and at a premium to par. If not called as presently expected, their book yields would increase to 3.75% after the call date passes. We also own $574 million of 15-year government agency securities, with coupons and book yields ranging from 2.96% to 3.17%. $250 million of these securities will become callable in late December, and $324 million will become callable in the first quarter of 2014. However, based upon current interest rates, we do not expect these securities to be called.

Operating costs and expenses were $19.5 million for the first quarter, compared to $18.7 million in the fourth quarter and $21.7 million in the first quarter of 2012. The increase from the fourth quarter 2012 was primarily related to an increase in compensation expense. The decrease from first quarter of 2012 is due to a reduction in state taxes and fees, and reductions in state exam fees. Our book value per share, excluding accumulated other comprehensive income, of $16.84 is up $0.35 from the December 31, 2012 book value of $16.49. Our RBC at March 31 was estimated at 330%, slightly down from 332% at the end of the year.

We sent out a notice of a mandatory redemption for our 5.25% contingent convertible senior notes due in 2024, in late March. $25.8 million principal amount, or 91% exercised their conversion right prior to the April 30 mandatory redemption date. The conversions are net share settlement, which means the principal amount will be paid in cash, and the conversion premium will be settled in shares of American Equity common stock. The final number of shares to be issued will be determined based upon the 10-day average closing price for American Equity common stock on the 10 consecutive trading days beginning on the second trading day, following the dates the notes were submitted for conversion.

As most of the conversions were not submitted until last week, the final number of shares to be issued is not known at this time. If the 10-day average closing price for each conversion was $15 per share, approximately 158,000 shares of American Equity common stock would be issued to satisfy the conversion obligation. The remaining $2.45 million of the convertible notes was redeemed for cash of $2.5 million, which includes accrued interest through the redemption date of $50,000. We will use holding company cash and a draw on our bank line of credit to fund our cash obligations, in connection with the conversions and redemptions of these notes. With that, I'll turn the call over to Ron to talk about sales and production.

Thank you, Ted. Good morning, everyone. As John reported, our first-quarter sales were $930 million. This is down slightly from our first quarter of 2012 of $979 million. If we look back in history for just a second, five years ago, 2008, our first-quarter production was $518 million, and 10 years ago, it was $314 million. It just reminds us how for American Equity has come over the years, and during some pretty difficult economic times.

Today, we have more momentum going into the second quarter that we did a year ago. Last year, at this time, our pending count was in the 2,900 to 3,000 range and going down. Today, pending is at its highest levels for the year, and we are in the 3,300 to 3,400 range. It seems that the general attitude today is more positive than it has been in the past year from both a general public perspective and a marketing perspective, and our agents and marketing companies feel it, and are projecting a better year. We don't think that there will be any spikes, but it will be better.

At American Equity, we're certainly optimistic, too. We introduced two new benefits and an agent sales contest on April 1. The benefits we introduced are not new to the industry, but they are new to American Equity. However, we don't consider ourselves a me-too company, so if we are not the first company to introduce something, we want to try and create some uniqueness, or make improvements. And one of the benefits that we introduced was an enhanced death benefit rider, and that is where we guarantee a 4.5% interest rate which is paid out at the death of the contract holder. To get the 4.5% rate the beneficiaries need to take a five-year payout, or if they want to take a lump sum, they can do that too, but it will be at a discounted value.

And of course, if the contract value is higher than the enhanced death benefit value, we pay that instead. There is a fee of 70 basis points if the customer or policy holder chooses to add it to the contract. We also introduced a well-being rider which doubles the lifetime income benefit rider payouts, and that is once the payout is actually income mode. And if the contract owner cannot perform two of six activities of daily living, we will double basically the income payments for a maximum of five years, and for this benefit, if they choose it, we have a 15 basis point fee. And these are introductory rates. We introduced these on April 1. We do anticipate some modifications on June 1.

While we are not the only company that is feeling optimistic, there have been some product introductions by other competitors. It seems that the more aggressive companies are not our long-term competitors, like Allianz and Aviva. It seems that most of our competition these days, or most of the aggressive competition, are from companies that are new to the marketplace, or companies that are considered what I consider in-and-outers. Basically, they get in the market with a hot product or a hot rate, and then when they have satisfied their appetite for new sales, they pull back. And what we're seeing today isn't really American Equity style, as far as aggressive competitors.

For example, we are seeing some new products introduced where they are reducing the penalty-free withdrawal provision from a 10% down to a 5%, and that gets them maybe a little more -- maybe a higher cap or a higher roll-up rate, or something. Or, they are changing the roll-up rates on their income benefit riders from compound interest to simple interest, so they can have a higher percentage to talk about. And we think we are also seeing some more exotic index-crediting strategies. So, one thing for sure is American Equity is going to stick to our principles. We have been in the top five for indexed annuity sales 51 out of the last 56 quarters, so we must be doing something right. And interestingly enough, over the last eight quarters, there have been five different companies that have been ranked number four according to Annuity Specs, and none of those five companies have managed to break into the top three.

We also had a successful $1 million producer forum this past March, where we had 300 Gold Eagle members in attendance. To refresh your memory, a Gold Eagle member is somebody that writes at least $1 million of premium for American Equity during a calendar year. In addition to those 300 Gold Eagle members, we had their guests and office staff, for a total of 550 attendees. I think it was our best program yet. We had many of the attendees tell us it was the best program yet. The problem with that is, we always have to improve it the next year, which so far we have been able to do, but we've got another one scheduled for next year again.

What makes the program special is we have our top 10 producers make presentations on their business strategies and their sales practices. When we talk about our top 10 producers, these are producers that write $13 million and above over the last year, so these are very successful people. Our other agents want to hear what is making them successful, and so they come. And in addition to making presentations individually, they also sit on a producer panel where they will take questions from the audience. We also have some outside the insurance industry speakers, too, to talk about organization, or maybe a motivational speaker, those types of things, though to lighten the mood a bit. So, it's been a great program for us, and we are going to continue to do it.

We have a very specific marketing plan, Kirby Wood and [Jeff Frisco] and Jessica Kilker, and all of those people over in the marketing area have put together a plan to make sure we engage all those Gold Eagle members that were at the $1 million producer forum. We want to make sure that they become Gold Eagle members again in 2013. We have been successful in retaining Gold Eagle members from one year to the next. Last year, as an example 58% of our Gold Eagle members we retained from the previous year, but we have more success for the top-level producers. So, for example, we only retained 55% for those producers that wrote between $1 million and $2 million the previous year, but that number spikes up to 82% if they wrote more than $2 million for us the previous year. Then, it spikes again to 86% if they wrote more than $5 million for us.

So, we really want to focus on those Gold Eagle members, and in particular -- we want to focus on all of them, but in particular, the ones that write $2 million plus. We also have on a Gold Eagle producer forum in our offices next week. This will be the first Gold Eagle forum we have of the year. We have some other ones during the course of the year, where our marketing company bring producers in. We are going to have 55 of our Gold Eagle members here. This is a chance for us to develop stronger relationships with these people. They will hear our story. We will roll up our sleeves and get in the products and benefits and features. They will hear about our investment portfolio philosophy, and of course, they get to meet the people who really do the heavy lifting around here, and that is the teammates that is keep this company on the go.

We are continuing our policyholder appreciation events. We will continue to do these as they continue to work for us. We do them every month except March, July, and November. So far this year, we've been at Charlotte, Atlanta, West Palm Beach, The Villages in Florida, Houston and Dallas, and we saw nearly 1,400 policy holders at these six events. We think they are catching on, because we have never had this problem before, and this problem is waiting lists. We had waiting lists at three of the six events, and that is just amazing to me. So far we have seen 11,500 policy holders and over 700 agents, and my description of these events just doesn't do them justice, it is something that you truly need to witness to appreciate. I know the policy holders feel better about their policy and American Equity after the event, and plus it always recommits our home office staff after we go to these events, because now we've met them, we had lunch with them, and we've engaged them, and they are not just numbers, they are people, imagine that. So, we always go home more committed than ever to do the best job we can.

As I mentioned earlier, we are optimistic about the future. We feel this is a great time to be in our business. While the stock market may be up, it seems pretty fragile at times. Yet, our indexed annuity policy holders can benefit when the market is up and still have that principal protection, minimum guarantees and lifetime income. In the first quarter, our average indexed annuity interest credit was 4.5% and the maximum for the quarter was 11.42%. 20% of our indexed annuity policy holders received between 4% and 5% in the first quarter. Another 19% received between 3% and 4%, and 15% of our indexed annuity policy holders received between 5% and 6%. If you add it up, 54% of our indexed annuity policy holders received between 3% and 6%, and not too shabby for a safe money type product.

Last, but certainly not least, our home office team continues to deliver excellent service to our agents and policy holders. I'm so proud of them, as I know all of the senior management team is. They do such an awesome job. I had a producer call me out of the blue the other day, and for no other reason, just to say, thank you for delivering on our commitments. He said our competitors won't, or they can't. So, when I look at our home office team and their longevity with the company, you can't help but be proud. When I look at our statistics, 36% -- excuse me, out of our 400 employees, 95 of them have been with the company between 10 and 14 years, and 36 of them have been with the company for 15 years or plus. So, nearly a third of our home office team has been with the Company for 10-years plus. And I think that is pretty impressive, considering we are a company that just has a 17-year history. And so with that, that concludes my report. I will throw it back over to John.

Thank you Ron and Ted, and just a quick summary before we take questions about the prospects for the balance of the year. As we've commented, the sales are off to a good start, and we are enthusiastic about what the second quarter is going to bring. Earnings are off to a good start as well, although with the redeployment of the cash and the expansion or reinstatement of the spread. Although just to caution, second quarter is likely to have an interruption of that because of the level of calls that we've already experienced. But, we are still enthused about getting that spread back up to the 3% target, as the year progresses. So, with that, we'll open the call up to questions.

(Operator Instructions)

Randy Binner, FBR & Co.

Just wanted to ask a few questions, if I could, just about the spreads and the elevated cash balance. And so maybe just picking up on John's last comment there about the interruption and the redeployment process, the way I'm thinking of it in our model is that this $678 million was anticipated, or it was announced by you all a while ago. So in my mind, it would basically keep the excess cash balance at its current level, maybe call it $1.6 billion to $1.8 billion. Is that the right way to think of it, that it kind of hovers around this level before it can get meaningfully worked down in the back half of the year?

Well, we ended the quarter at $1.2 billion, Randy. The $1.8 billion was the average for the quarter.

Okay.

So, but I would think that balance when we end the second quarter is going to be above the $1.2 billion.

Okay, so, okay, that's helpful around the clarification. So some thing like between $1.2 billion and $1.5 billion?

It could be even higher than that. The other thing we are seeing at the moment I guess is that there has been a backup in treasury rates, and that slowed a little bit in the securities we are investing in. I know we are not quite at the same pace of investing as we've made in the first quarter. So, it could be on the high-end of $1.8 billion to $2 billion number, unless the pace really picks up.

Okay.

Ending balance at the end of Q2.

Right. Okay. So, I got -- my conclusion was right with the wrong numbers, but I'll take it. So then on the money you're putting to work, you mentioned that you are purchasing some new government, I think you said some government RMBS at 312 basis points, what is that exactly? If I heard that correctly?

It is not RMBS. It is agency securities of the type that have caused all the calls now, but they don't get called if rates stay at these levels.

Okay. And so that's a good segue into the third part of my question, and that is, I missed the July call amount, sorry that went by too fast. What was the amount that you said was up for call in July?

It's $504 million, but those securities, we consider those short-term investments, so they are already in the $1.2 billion cash balance number.

Okay. Got it. That is helpful, because didn't I recall hearing about the July cut out. But what is the yield on those?

The yield is 75 basis points, if they don't get called, although they are expected to be called, the yield would jump up to 3.75%.

So, they'll get called. Looking into the other amounts you referenced through December and January, would those be similar to these new agency securities you are buying in that if rates stay at current levels, they would be less likely to be called?

If rates stay at current levels, they will not be called.

Is there a level of rates as measured by the 10-year, where we would think about the new agencies, or those other ones in December and January getting called if rates, if the 10-year broke out to 2.50% or something like that?

If the 10-year goes up, they won't be called. If the 10-year, Jeff Lorenzen, do you have any insight into what level the 10-year might need to drop to, before those things would be at risk of being called?

I think you need to be well below 1.5% on the 10-year.

Okay below 1.5%. I misspoke. I said up, not down, so 150 is the floor there. That's it on my end. Thank you.

Steven Schwartz, Raymond James & Associates.

Just a follow-up a little bit, Ted, how much did you invest in the quarter in long-term bonds and in other long-term instruments in CML?

Jeff, if I'm right I think it was $1.3 billion, is that our run rate?

Sounds about right, yes.

Okay. And John, you're intimating that given the backup in rates, that it might be a little bit less than that this quarter?

The number in the quarter was $2.3 billion that we put to work.

In long-term?

In fixed, yes, in long-term securities, yes.

Okay. All right, very fast rate actually. Okay, and then just on the business wise, Ron, you seem to intimate that your historical competitors were behaving themselves. Do we take from that, that we haven't seen anything new out of Aviva, Ameris, Athene, since the takeover?

Well, Aviva has introduced a new product that is based around income, and that is really what they are targeting there. Although, according to the field, it hasn't really taken off. It sounds like it might be a little complex. So, it sounds like a product that is what I would consider, as you said, Steve, it behaved, it's a well-behaved product, but it's a little bit complex, so sales aren't really taking off on it. Athene introduced a product under the umbrella of Athene which we thought was a little bit aggressive, but we haven't really seen sales take off on that either. So, it will be interesting to see what the second quarter brings.

Okay. And then just looking at some statutory things. There is a change in formulas regarding mortgage-backed securities. John, anything to note there?

Not sure I know what you're talking about there.

Okay, maybe I don't know what I'm talking about.

There already was a change, like last quarter already, where they changed the weighting on the various scenarios and they gave a higher weighting to some more of their severe scenarios, but that did not have really any large effect.

Steven, I think what you may be thinking about, the mortgage-backed securities have been dealt with going back several years ago, in the FIMCO process, that assigned values to each security that then determine the category it fit into and that process, I think, was extended to CMBS and maybe some asset-backed securities. What is going on is in the direct commercial mortgages.

Okay there you go.

They are coming up with a system, and I believe I have heard that the commissioners had a telephonic call or whatever, and approved this, just this week, although I'm not absolutely certain of that. But it sounds like this is headed toward implementation, where the concept for commercial mortgages, which we've had this mortgage experience adjustment factor, the MEAF, the acronym, that is going to disappear from commercial mortgages, I don't think this year, I think next year.

And the risk-based capital for commercial mortgages is going to be based upon some objective information loan-to-value ratios, debt service coverages. I think I've heard also that for instance some -- you can have -- we have a lot of commercial mortgage loans with ten-year final terms and 25-year amortizations.

We don't have any interest-only, but other life companies do. So there is going to be some sort of conversion that puts all loans on the same basis, so that you can obviously have a better -- you have a higher debt service coverage if you only have it as the coverage are only having to pay interest versus principal and interest, so there's going to be a mechanism to standardize the terms of the mortgages, so that it's apples to apples among all companies.

Okay, but nothing yet to really get --

I believe that is 2014, is when it gets implemented.

Okay. Thanks, John.

Mark Hughes, SunTrust Robinson Humphrey.

In order to get back to that 300 basis point spread target, how much would have to you have to do on the crediting side to get there? Can you just talk about the steps that you have to take in order to return to your goal?

Mark, I don't have a fresh analysis, what I had from about six weeks ago was another 15 to 20 basis points. And we will be making another updated analysis in the very near future to make sure that is going to get it done.

And when might that be implemented?

Early third quarter it will start.

Okay. And then from a competition standpoint, those in-and-outers, or new entrants that are more aggressive, is the level of that activity, is that consistent with prior quarters? Was it a little less this quarter, and that's why you're getting an uptick in sales activity, or is the underlying demand so strong that it's overcoming even more of that competition?

I think it is maybe a mixed bag, Mark. I think there is certainly demand for the products as the baby boomers start to retire, and recognize the value of them. I think we can also speculate that as Aviva is being sold, that there might be some agents who aren't sure of what the final outcome is going to be, so we might be able to get some market share from them. Allianz has been pretty quiet, we might be getting a little bit market share for them. So I think it's kind of them mixed bag, I don't know if we can put a finger on any one thing that is doing it, Mark, but I think it's a little bit of each.

Thank you.

At this time, there are no additional questions in the queue, and I would like to turn the call back over to management for closing.

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

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.