American Equity Investment Life Holding Co
NYSE:AEL
Earnings Call Analysis
Q1-2023 Analysis
American Equity Investment Life Holding Co
Total sales reached a remarkable $1.4 billion, with a significant sequential quarter increase of 23% in fixed index annuity sales, which stood at $964 million. American Equity Life witnessed a 16% rise in FIA sales, while Eagle Life sales jumped an impressive 57% quarter-over-quarter, and a notable 80% compared to the previous year. The economic climate has created a favorable environment for the company's products, with income product sales climbing 12% from the previous quarter and a substantial 50% year-over-year, hitting $528 million in total.
The company successfully increased its investment spread to 2.67%, marking a noteworthy 12 basis points improvement. This consistent and strategic performance resulted in operating earnings that reached $1.47 per share, indicating a solid quarter for profitability and efficient use of capital.
The investment portfolio has undergone a transformative diversification with increased capital allocated to private assets, accounting for 24.2% of the allocation, a notable rise from 22% at the end of the previous year. New investments were strategically distributed across several sectors such as residential real estate and infrastructure, with the anticipated returns on new investments contributing significantly to a higher average yield on assets, which moved up to 4.48% from 4.30% in the preceding quarter.
In response to the heightened interest rate environment and associated financial risks, the company has prudently reduced exposure to regional banks from $247 million to $132 million. It has also deliberately avoided risk-prone subsectors such as nontraditional consumer finance and certain high-velocity tech business models, focusing instead on areas with strong cash flows and good long-term fundamentals.
The company boasted a strong liquidity position with $690 million in cash and cash equivalents at the end of the quarter, a figure that has since increased to over $1 billion. With no outstanding borrowings on its Federal Home Loan Bank line and a strategic holding of high-quality, short-duration assets on the balance sheet totaling $2.3 billion, American Equity maintains a 'fortress balance sheet,' showcasing its preparation to manage any market fluctuations and uphold its long-term strategic initiatives.
You don't have any saved screeners yet
Welcome to American Equity Investment Life Holding Company's First Quarter 2023 Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Julie Heidemann of Coordinator of Investor Relations.
Good morning, and welcome to American Equity Investment Life Holding Company's Conference Call to discuss first quarter 2023 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com.
Non-GAAP financial measures discussed on today's call and reconciliations of non-GAAP financial measures to the most comparable GAAP measures can be found in those documents or elsewhere on our Investor Relations portion of our website. Presenting on today's call are Anant Bhalla, Chief Executive Officer; Jim Hamalainen, Chief Investment Officer; and Axel Andre, Chief Financial Officer. As a reminder, our financial results reflect the adoption of accounting standard update 2018-12, more commonly known as long-duration targeted improvements or LDTI.
Long-duration targeted improvement accounting guidance was adopted at the beginning of the year and prior year results have been adjusted accordingly. Some of our comments will contain forward-looking statements which refer or relate to future results, many of which we have identified in our earnings release. Our actual results could significantly differ due to many risks, including the risk factors in our SEC filings. An audio replay will be made available on our website shortly after today's call. It is now my pleasure to introduce Anant Bhalla.
Good morning, and thank you all for your interest in American Equity. Positive changes in the way we go to market have begun to bear fruit. In the first quarter of 2023, we had total sales of $1.4 billion, driven by a 23% sequential quarter increase in fixed index annuity sales to $964 million.
At American Equity Life, FIA sales increased 16% from the fourth quarter of 2022, with solid gains in the sales of both income and accumulation products. Eagle Life sales increased 57% from the fourth quarter and 80% year-over-year. Periods of sustained capital markets uncertainty are a tailwind for our go-to-market strategies as lifetime income and principal protected accumulation products become more appealing for advisers and agents to position with their clients.
In particular, the income story we've been telling over the past 2 years at both American Equity Life and Eagle Life resonates at this point in the economic cycle. In turn, this supports our reinsurance strategy. We had total income product sales of $528 million, up 12% from the fourth quarter of 2022 and 50%, 5-0 year-over-year, approximately 75% of which was reinsured. At American Equity Life, sales of income products were $427 million, up 12% from the fourth quarter of 2022 and 37% year-over-year. Eagle Life sold $100 million of select income focus, a quarterly record for us in the bank and broker-dealer channels, backed by our new flow reinsurance agreement with 26North, which became effective February 8th, multiyear fixed rate annuity sales totaled $404 million between American Equity Life and Eagle Life.
In the quarter, we ceded $228 million of these sales to 26North RE. While we seeded 100% of multiyear fixed rate annuity sales to 26North RE, up to $525 million annually, we do receive some fee income on account value seeded, but more importantly, it allows us to gain mind share in the bank channel that can translate into greater FIA sales. For 2023, we expect to meet or exceed our stated sales goal of $4 billion in FIA sales while writing a meaningful amount of fixed-rate annuities at attractive cost of funds in this market. I'm pleased to share through May 5th, this quarter, total enterprise FIA sales are approximately $600 million.
In Investment Management, we deployed another $1.3 billion in private assets at an expected return of 7.89%, bringing our total allocation of private assets to 24.2% compared to 22% at the end of the year and 15.5% at March 31st, 2022. Across sectors, we remain deliberate, focusing on underlying assets with resilient cash flows even in a down cycle where the majority of return is delivered by underlying operating performance of the asset and not its terminal value. Additionally, we seek our private assets where there is an inherent advantage for an insurance balance sheet to own the assets to avoid competition with asset managers that use capital structures for private assets that rely on low-cost leverage to justify buying lower yielding unlevered assets and/or may assume multiple expansion on exit.
In the current market, given the absence of low-cost public financing or securitization for managers, REITs and private asset companies to fund real assets, American Equity has an asset sourcing advantage. That is significant tailwinds that allow us to be even more selective in making our risk selection underwriting decisions.
In the first quarter, we emphasized residential mortgage loans and U.S. middle market corporate loans and put significant dollars to work in infrastructure debt. I'll let Jim cover more specifics about the investment portfolio in just a few minutes. In our capital reinsurance pillar, fee-generating reinsured balances increased to $10.2 billion from $9.6 billion, driven by flow reinsurance on $634 million of account values, exceeding targets we outlined when we embarked on AEL2.0 at the end of 2020.
During the quarter, we executed the repurchase of 7.3 million common shares for $253 million, which includes $160 million of the $200 million accelerated stock repurchase program, or ASR, that we announced on March 20th. We expect to complete the ASR this summer to be followed by the return of an additional $87 million to shareholders through share repurchases and common stock dividends by year-end, effectively completing our promised capital return for both 2022 and 2023. With this, we will have repurchased 14.75 million shares or 16% of our common equity share count since January 1st, 2022. Including common stock dividends paid in the fourth quarter of 2021 and 2022, we will have returned $749 million or $0.75 billion to shareholders in excess of dilution from Brookfield equity tranche II offerings that represents 27.4% of our market capitalization as of September 30th, 2021.
Before I turn it over to Jim, I would like to say how pleased I am with the quarter's results. We reported operating earnings per share of $1.47 per share, including one notable item of $0.11 despite a negative true-up on our tax rate and some quarterly volatility in the returns on our mark-to-market investments. We increased investment spread by 12 basis points to 2.67%, up from 2.54% in the fourth quarter of last year, demonstrating that AEL 2.0 can deliver top quartile investment returns for an insurance balance sheet. I'll now turn it over to Jim to talk about the investment portfolio results and resilience.
Within investments, we continue to successfully execute the transformation of the portfolio that we started almost 3 years ago. The repricing in public markets over the past year has given us the opportunity to not only continue the private asset deployment strategy we communicated when we began, but also deploying money into core public assets with solid credit profiles, attractive returns and good liquidity. Deployment into private assets remains the focus, though, with just over 60% of cash deployed going into private assets for the first quarter. Markets have been volatile with new potential risks emerging, but the strategy we're executing benefits from opportunistic investing at given points in time and is rooted in long-term fundamental value.
The market today offers a wide range of opportunities that fit our risk-return criteria, meet the long-term objectives set out as part of the company's strategy and support the sales of our suite of annuity products. I'll take you through some of the key highlights and particularly cover some of the key market sectors that have been receiving a lot of attention recently. Now before diving into our update on portfolio performance details, I'd like to mention that our recent portfolio stress testing updated for the current market outlook produces results that are similar to those we presented in our December 7th Investor Symposium.
We believe the disciplined underwriting in the private asset portfolio we have built over the past 2.5 years will help limit downside performance in a recessionary environment. For example, our focus on pockets of residential real estate that are benefiting from significant housing supply shortages should help mitigate pressure from higher mortgage rates on this portfolio. Similarly, we expect rental income to remain resilient. While it may not increase at historical rates, market expectations for the geographies in which we hold real estate of continued growth in rental income. Our more recent vintages of private corporate credit are all post COVID with robust debt service coverage ratios even at current SOFR rates with over 50% equity collateral underneath them.
The relative size of the legacy AEL 1.0 public structured assets portfolio to our balance sheet has been significantly reduced compared to 3 years ago. As we sold close to $6 billion of core fixed bonds just over the past 5 quarters as part of continued repositioning the portfolio into higher risk-adjusted yields.
This proactive risk reduction of the portfolio resulted in less than a 1% realized loss, more than offset by higher investment income on the redeployed assets. This investment portfolio resilience speaks to the credit focus we maintain in our investment underwriting as we continue to execute the transformation of the portfolio. Now some of the details. First, results. In the quarter, we made total investments of $2.1 billion at an expected return of 7.19%, including $1.26 billion of privately sourced assets and an expected return of 7.89% as well as $805 million of core public assets at expected returns of 6.09%. This brings our allocation, as Anant mentioned, to private assets to 24.2% compared to 22% at the end of December and 15.5% as of March 31st of 2022. New investments were sourced across sectors, including $500 million in residential real estate and an expected return of 6.9%, $187 million in the infrastructure sector at an expected return of 7.75% as well as investments in middle market credit, commercial real estate and agriculture.
Across sectors, we remain focused on underlying assets with strong cash flows and good fundamentals through economic cycles. Underlying long-term fundamentals in the residential real estate market continue to be strong. While there have been areas in the country where house prices have dropped, there are other areas where prices have continued to rise through the cycle. Rental rate changes also remained strong, particularly in the Sunbelt region, where we have made a substantial portion of our investments. The continued lack of housing supply relative to demand should support the residential real estate market going forward.
We also remain constructive on the opportunities in middle market credit, where we are still scaling into this asset class, leveraging our best-in-class partners, -- at this point in the cycle, has been great timing for us as we are able to underwrite deals at lower leverage and wider spreads than pre-COVID. The underlying portfolio of companies we have underwritten are performing well, and we remain focused on adding exposure only where both risk and spread per unit of risk is appropriate in the current environment. Average yield on invested assets was 4.48% in the first quarter of 2023 compared to 4.30% in the fourth quarter of 2022.
The sequential increase was primarily attributable to expected returns on new money, substantially above portfolio rates and a 7 basis point benefit to the portfolio from the increase in short-term rates on our floating rate assets, which together more than offset a decline in investment income from partnerships and other mark-to-market assets. Partnerships and other mark-to-market assets are reported primarily on a one-quarter lag basis. While they had a positive contribution to investment income that was well within the expected range of variance, the contribution was $21 million or 17 basis points of yield less than the assumed rates of return used in our investment process for the first quarter.
While the return on partnerships and other mark-to-market assets was 3.6% in the quarter compared to an expected return of 7.5%, our longer-term experience continues to meet or exceed our assumptions. The shortfall from expected was primarily driven by valuations of our single-family real estate portfolio, which now totals just over $1 billion. As I mentioned earlier, underlying fundamentals remain solid, with returns driven from strong rental income, offset by a valuation change that reflects higher discount rates, lower initial 3-year average rent growth than in prior periods and an increase in expense assumptions.
The sharp increase in short-term interest rates of 500 basis points over the last 15 months has created stress in parts of the financial system with a visible impact on certain regional banks. Including activities in April and May, we have reduced exposure to regional banks to $132 million from $247 million at year-end. This is a small portion of the total investment portfolio, less than 1/3 of 1%, which is predominantly invested in super regional banks. We remain vigilant and continue to monitor the situation closely for potential contagion to other banks, other financial companies and other sectors of the market, especially in the public bond portfolio and loan book.
Underwriting the funding profile of businesses is core to how we assess risks in our private asset portfolio. Along with some idiosyncratic situations in banking with super short funding models that are impacted by an inverted yield curve, we see sectors like nontraditional consumer finance and tech-enabled high-velocity business models at greater risk of funding dislocation. American Equity has stayed completely away from these subsectors by choice. Another area under the spotlight is the commercial real estate sector, particularly exposure to office properties. The most acute stress is associated with high-cost buildings and central business districts in certain markets that are experiencing the double headwinds of lower occupancy due to slower return to office post COVID or hybrid work models and high barriers or cost to repurpose the assets to multiuse given the required CapEx, high refinancing costs and other friction.
We have not been big lenders in the office sector of commercial real estate, so our exposure is low both on a relative and absolute basis. Let's go through key details of our exposure to office properties. First, covering the direct commercial mortgage loan book and then the CMBS exposure in the portfolio. Looking at the exposure to the office sector across the direct commercial mortgage loan book, the total exposure is $257 million across 55 loans, which is just 8% of the commercial mortgage loan book. All of these are senior loans and almost all are amortizing. There are no delinquencies in the portfolio, and we have a very manageable maturity schedule over the next 3 years with $41 million of loans coming due through the end of 2025. Nearly 2/3 of the exposures were originated prior to 2020 and have seasoned in line with expectations.
We continue to actively monitor the health of the portfolio through our internal assessments based on the underlying financials of the properties. Loan-to-value and debt service coverage ratios remained strong. Our average loan-to-value ratio for office loans is 55%, and our average debt service coverage ratio is 1.86x. To generate the loan-to-value ratios, we use a third-party appraisal process at the inception of each loan and use third-party appraisals when a loan is refinanced or goes into foreclosure. Otherwise, we internally evaluate each property at least once per year. This is a typical practice used by many companies in the industry -- in addition, our commercial loan book has a low exposure to central business districts of only $65 million. The rest of the commercial mortgage loan portfolio outside of the office sector is also performing well with no delinquencies.
We have 30% of our commercial mortgage loan exposure in multifamily housing and apartment rents are increasing at a slower rate than the past years, but their absolute levels remain high by historical standards. The strong demand for housing continues as there remains a shortage of vacant rental properties. The industrial and warehouse sector makes up another 27% of the portfolio, and this sector has been generally recession-resistant and is a part of the market that we like for both transition loans as well as equity investments. In addition, another 25% of our commercial mortgage portfolio is in retail, 100% of which is grocery-anchored or strip for service-oriented strip malls. We have no department store exposure in the portfolio. Looking at some metrics across the entire commercial real estate book, almost all of the loans have a loan-to-value ratio of less than 80%, and a significant majority of loans have a debt service coverage ratio of greater than 1.5x. Moving on now to CMBS Holdings. We have done significant derisking in the book over the past 2.5 years.
Our overall CMBS exposure has gone from 10.1% to 8.2% of the portfolio, while migration up in quality has reduced exposures rated BBB lower from going from 0.8% of the total investment portfolio to just 0.2% of the portfolio. We have just over $1 billion of exposure to office through non-Agency CMBS on our books. This is near the average level of office exposure within the CMBS market. 98.1% of the total CMBS portfolio is rated NAIC 1 and 99% is rated NAIC 1 or 2. Additionally, the average credit enhancement in our office-related CMBS holdings is 29%, which is reflective of the seniority in most of the holdings. Our office-related exposure in SASB bonds is included in our totals and each underlying property has been underwritten. Our internal team continues to partner with our external asset managers to review exposures to property types within our CMBS book. The structural enhancements provide meaningful protection to our exposure to office.
As always, we continue to focus on liquidity in the portfolio. We think of liquidity in many layers, the most readily available are cash and cash equivalents on the balance sheet. At quarter end, the operating companies had $690 million of cash and cash equivalents. That number is higher today with over $1 billion or approximately 2% of the portfolio in cash and cash equivalents. The company's ability to draw on its FHLB line is another readily available source of liquidity. And at quarter end, the company had just $100 million drawn. Today, the full line is available as there are no outstanding borrowings. In addition to these sources of liquidity, over the past 3 quarters, we have also purchased very high-quality AAA and AA rated short-duration structured assets that provide another readily available source of liquidity in the portfolios.
Currently, there are $2.3 billion of these securities on the balance sheet. And in total, we have $3.7 billion of publicly traded bonds in an unrealized gain position. We will continue to manage liquidity prudently, especially with the potential for a continued economic slowdown and the possibility that even in a slowing economy, the Federal Reserve may not cut rates as quickly as priced into current market expectations. As we move through the year, our focus will be to continue on maintaining our fortress balance sheet, both from a capital and liquidity perspective, while executing our long-term strategy. Our strategy remains on track, and we continue to closely follow economic developments in the markets. With that, I'll turn it over to Axel.
Let me extend my appreciation to all of you attending this call. Before I start, I want to notify you all that we have updated the press release and financial supplement on our website to correct an error that affected 2 lines on Page 9 of the financial supplement as originally reported and Page 3 of the press release. The lines are the net impact of fair value accounting for derivatives and embedded derivatives as well as the net capital market impact on the fair value of market risk benefits. Notably, total common stockholders' equity excluding AOCI as well as total common stockholders' equity excluding AOCI and the net impact of fair value accounting for fixed annuities are both unchanged. We will issue an amended 8-K shortly following this call, reflecting those items I just mentioned. For the first quarter of 2023, we reported non-GAAP operating income of $124.3 million or $1.47 per diluted common share compared to non-GAAP operating income of $107.1 million or $1.09 per diluted common share for the first quarter of 2022.
Operating income for the first quarter of 2023 included one notable item of $9.6 million or $0.11 per share after tax, reflecting the special incentive compensation plan put in place in November of last year. There were no notable items in the first quarter of 2022. The quarter included $22.4 million of operating revenues from reinsurance agreements, up from $19 million in the fourth quarter of last year. Included in revenues from reinsurance agreements this quarter was a positive $1.2 million true-up associated with the final settlement of the 26 North RE reinsurance transaction. Except for this nonrecurring benefit, the increase in revenues versus the fourth quarter primarily reflected flow reinsurance of income products ceded to North End Re.
As Jim mentioned, average yield on invested assets was 4.48% in the fourth quarter of 2023 compared to 4.30% in the fourth quarter of 2022, driven by strong new money yields and an increase in short-term rates offsetting lower returns on the mark-to-market portfolio. The average adjusted yield, excluding nontrendable prepayments, was 4.48% in the first quarter of 2023 compared to 4.29% in the fourth quarter of 2022.As of March 31st, 2023, the point-in-time yield on our investment portfolio was 4.68% compared to 4.44% at year-end, reflecting the benefit from the increase in floating rate indices, an increase in yields on our public asset portfolio, reflecting portfolio management trades and a further increase in our allocation to privately sourced assets.
For the second quarter, we expect an additional benefit of roughly 6 basis points in yield, reflecting the increase in short-term rates on our $6.2 billion floating rate portfolio. The aggregate cost of money for annuity liabilities was 1.81% in the first quarter of 2023, up from 1.76% in the fourth quarter of 2022.The cost of money in both quarters reflected near zero hedge gains. The sequential increase in the cost of money primarily reflects a higher cost of options purchased in the first quarter of 2023 compared to the runoff of lower cost options purchased in the fourth quarter of 2021. Cost of options in the first quarter of 2023 averaged 1.79% compared to 1.61% in the fourth quarter of 2022. The increase reflected both market effects on the cost of options for renewals as well as higher option costs on new sales as we've raised caps and participation rates on our FIA products over time, consistent with the interest rate environment.
We estimate that roughly 20% of the increase in the cost of options was associated with new money rates. Investment spread in the first quarter was 2.67% compared to 2.54% in the previous quarter. Excluding prepayment income and hedging gains, adjusted spread was 2.67% compared to 2.53% in the fourth quarter, reflecting the higher effective yield on the investment portfolio, offset in part by the increase in cost of money. Deferred acquisition costs and deferred sales inducement amortization totaled $115 million in the first quarter of 2023 compared to $113 million in the fourth quarter of 2022. First quarter expense included $1 million of amortization costs associated with new sales. For the second quarter of 2023, we expect combined deferred acquisition costs and deferred sales inducement amortization of $114 million before the effect of new sales and experience variances.
The change in market risk benefit liability increased to $47 million for the first quarter of 2023 from $31 million in the fourth quarter of 2022. The $16 million increase in the change in the market risk benefit liability primarily reflected a $4 million increase in expected a $7 million relative net negative variance in actual to expected results, a decline of $3 million in the benefit from amortization of the net deferred capital market impact and a $3 million model true-up. In the first quarter of 2023, the reported change in market risk benefits was approximately $8 million more than modeled expectation, consisting of $2 million of adverse behavior, primarily lifetime income benefit rider utilization, $3 million from model true-up and $3 million decrease in the benefit from the amortization of capital market impacts on the fair value of market risk benefits.
For the second quarter, we have a model expectation of $46 million, including an expected benefit from the amortization of capital market impact on the fair value of market risk benefits of $15 million to $16 million per quarter. The MRB or market risk benefit net deferred capital market impact decreased from $766 million at year-end to $629 million at the end of the quarter, reflecting amortization of $16 million and negative market impact of $121 million. Negative market impact primarily reflects a reduction of approximately $131 million due to lower long-term interest rates. As of March 31, 2023, we estimate that a 100 basis point shift upward in the risk-free yield curve would increase the MRB net deferred capital market impact by approximately $416 million, while a 100 basis point shift downward across the yield curve would result in a $510 million decrease. The amount of amortization resulting from the increase or decrease in that deferred amount is approximately 2.4% of that amount per quarter.
An increase in the equity markets of 10% would raise the market risk benefits net deferred capital market impact by roughly $24 million, while a decrease in equity markets of a like amount would result in a decline in the MRB net deferred capital market impact of $28 million. And lastly, zero index credits in the quarter would decrease the market risk benefits net deferred capital market impact by approximately $5 million. Our effective tax rate for the quarter was 24.4%, including a $6 million true-up related to last year. Exclusive of this amount, our effective tax rate was 21.2%. Gross outflows in the quarter, including income utilization and partial withdrawals totaled $1.2 billion. This was basically flat with the fourth quarter or an annualized run rate of approximately 10% of annuity account balance. The net account balance growth in the quarter was a negative $473 million or 1% of account values impacted by minimal index credits.
This was an improvement compared to a net account balance decrease of $598 million in the fourth quarter with similar index credits. As of March 31st, cash and equivalents at the holding company were $437 million compared to $534 million at year-end. The decrease reflects $293 million of cash used for share repurchase, offset in part by tax sharing payments from the insurance entities to the holding company. Our internal estimate for rating agency excess capital stands at over $650 million at the end of the first quarter, while our financial leverage is relatively low at 13.5%. With that, thank you for your attention, and I'll turn it over to the operator to begin Q&A.
[Operator Instructions]
The first question comes from Erik Bass with Autonomous Research.
Hi. Thank you. You indicated at the December Investor Day; I think that a modest recession scenario could have about $350 million of impact on capital. It sounds like your outlook for that is still pretty similar today. I was just hoping you could provide a little bit more detail on the underlying assumptions, where the majority of the capital impact is expected to occur. And then also how much the impact could go up if we were ahead of a more severe recession scenario.
Sure, Erik. This is Axel. Yes, you're correct that we run that moderate recession scenario on a quarterly basis. The impact of that scenario continues to be approximately $350 million. In that scenario, from a capital management perspective, we view that the excess capital position enables us to absorb that impact and continue with our planned capital return to shareholders. I would say that the majority of the impact in that scenario has to do with downgrades and the resulting increase in required capital. And then a smaller fraction is -- comes from actual credit losses that result from the scenario. And with that, I'll pass it on to Anant.
I'll add into the color that -- and Jim, feel free to jump in as well. We feel good about the $350 million because it's sort of a bottoms-up view as mentioned. Maybe I'll provide a perspective on how we think about the market going forward from here. We think rates are going to stay higher for longer. We think the curve is probably going to remain inverted. Businesses or structures that are exposed to financing risk are the ones that could probably suffer those kinds of downgrades. You have to look at idiosyncratic risk and really not systemic risk where we are right now. Our exposure to sectors that people are concerned about, like office is very low, as Jim mentioned. Even listen a very much bottoms-up view that we don't feel very exposed in those sectors. But rates are going to stay up for longer, and you are going to see businesses see the trickling effect of that. We feel really good about our private asset portfolio, especially middle market credit because there's like 50 points of equity cushion underneath us when we're doing these deals. We've got recent vintages. We like private -- middle market private credit over legacy CLO positions with Jim and team have derisked and that's a market we're hunkering down for. We're hunkering down for a prolonged period of uncertainty from the Fed and a likely economic recession.
And I totally agree. I mean, I think we're thinking about it in terms of looking for investment opportunities that will be resilient even in a prolonged downturn. Obviously, you've come up with a severe enough scenario that everything you get in trouble. But we're thinking about it in terms of the hierarchy around the strength and stability of companies being able to withstand higher rates for longer and a slower economy for longer.
And lastly, I'll add that we also run severe recession type scenarios. For now, this is a scenario that's GFC like. We're constantly in the process of refining those scenarios, in particular, reflecting the particular of the type of environment that Anant and Jim just mentioned. But aside from that, in a GFC type scenario, we would see about twice the amount of capital impact that I mentioned for moderate scenario, which, again, we feel we're able to absorb from an excess capital perspective, and that's what I'm going to say about it.
And then maybe secondly, I was hoping you could talk a little bit more about your expectations for the cost of money going forward. I know you gave some numbers in the script. But should we sort of think of the sequential increase from the fourth quarter is a reasonable estimate? Or how, I guess, should we think about modeling that going forward?
For cost of money, well, first, cost of money is a function of cost of options like we've talked about in the past, it's kind of the trading average of cost of options. And so for cost of options, as I mentioned, 2 components. One is the impact of new business. New business is priced to our profitability targets. And as you know, the raw ingredients, the starting point is the new money yield. If new money yields are higher, we're able to offer higher rates, higher cost of options, therefore, while meeting our profitability hurdles. In an environment where, like we just mentioned, we're able to invest at 6% and above, you would expect the cost of options that we're able to offer to be higher. And then second component of the increase is what we rate renewal actions on the in-force, which are going to depend on the environment. They're going to be supported by the overall book yield. As that book yield increase in theory, we may be able to offer higher rates on in-force. But those decisions are very tactical and based on the specific book of business that comes up for renewal. As well as the current state of the investment book yield.
The only thing I would add to Axel's comments is that even though we have a very mature and aged book as it comes off so under charge protection, we see lapses will be manageable even slightly elevated versus history, but manageable because a lot of our book has lifetime income benefits on it, including without fees. The key is in us reminding people, clients and advisors they have a benefit and they should not walk away from it especially if they get older. That's really the value of our book that a lot of books don't have, the lifetime income benefits without fee.
Putting it all together, you would still expect at this point, to see spreads increase and get to kind of the levels you talked about at the Investor Day?
Yes, that's right. That's correct.
The next question comes from John Barnidge with Piper Sandler.
Thank you very much. And good morning. You ramped the level of private asset allocation higher in the quarter. What's your revised thinking on where the company ultimately lands in that targeted range? I seem pretty pleased with how it's performed so well. Thank you.
Hi, John. This is Jim. We are still sticking with our long-term 30% to 40% targeted allocation. We think that that's the right place to be from a long-term perspective and being very careful, of course, with underwriting, we think that we can continue to ramp into that range.
You had asked us last quarter, did we expect to get to the lower end of that range in '23 and Jim's answer was no, I think the answer remains the same. We just have a lot more opportunity, not to get ahead on your question, but I remember it from last time, there's a lot of opportunity, as Jim mentioned, for us to be even more selective and frankly, public assets have great returns right now as well. That's why Jim and team are balancing. You'd agree with that, Jim?
Totally agree.
Utilized more reinsurance in the quarter for sales. How should we be thinking about this ramping prospectively as well and as you target maybe exiting '23?
And this is the question back, John, correct me if I get any part of it wrong. You think how should we think about the use of reinsurance as we're ramping sales for exiting 23?
If I were to look at the amount of coinsurance ceded as a percent of gross sales, it continues to increase. Where do you see that trending towards exiting '23? Do you think it's 50%?
I think we're trying to drive gross sales first, and we have solid momentum on FIA. In the case of FIA, we see 75% of our American Equity Life income sales to BAM, and we've got the fixed annuity sales that go to $26 million up to $525 million. We probably will see the retention from us increase on that as we do want to manage our retained assets under management, too. But as we execute our sidecar, AssetShield will start to go into the cycle or a portion of AssetShield will start to go into it. It depends on mix. Would we be at 50%. We will be run rate 50% once we execute the sidecar, but not for the year.
The next question comes from Ryan Krueger with KBW.
Hi. Good morning. I had a question on investment spread. If I take what you did in the quarter and I normalize for your expected mark-to-market asset returns, you're at about 2.84% for the investment spread and you had targeted getting up to 2.9% by 2025. It seems like you're pretty far ahead of plans. I guess I just want some perspective but do you think it's going to start to level out more? Or do you think at this point in time, you may have upside to what you had been contemplating at the December Investor Day?
I think the investment environment has been great, right? You look at this quarter, we've been able to put $2.1 billion to work at very attractive yields. I think that's probably relative to the plan relative to what we had in mind when we spoke at the investments in symposium, that's probably upside relative to that. We've been certainly very pleased with that. A big portion of it is going to be hard to forecast or as good as any forecast is, which is that it's invariably wrong. And based on where we're able to put new money to work.
And can you give us an update on your progress towards establishing the first sidecar this year?
The sidecar continues to progress very well. We see interest from -- as I mentioned in the last call or the call before the last call, we'll probably look to execute in the third quarter, and we have solid interest from a couple of pristine counterparties. Frankly, the interest is to get more of the flow, and that's sort of what we're negotiating, whether how much we keep for our own balance sheet, how much of flow we commit to, and that's really important for us to -- as we manage earnings going forward. But that's the value of having a franchise like AEL, where people want these liabilities.
The next question comes from Tom Gallagher with Evercore.
Hey, good morning. Just wanted to level set how we should think about go-forward GAAP earnings here. Just looking at the pieces of adverse alternative returns, the unusual expenses, I would normalize to $1.77 of earnings. Just want to see if there's anything unusual on that actual. I tried to follow the pieces of the market risk benefits plus the DAC amortization. It didn't sound like to me like there was anything that was going to be a big trend change into 2Q. But just wanted to double check if that's kind of a good starting point.
I think it's a reasonable way to think about it, right? And of course, I'll take normalized returns on the mark-to-market assets as much as you would as well. And that's going to be a source of variability. There's going to be quarters like this quarter where it's less and quarters like in prior quarters where it's materially more. But in terms of forming kind of a normalized view, I think that's a reasonable starting point on the mark-to-market assets. I think removing nonrecurring items to the extent that we are able to identify them is also a good starting point. So yes, I don't see anything unreasonable with what you just mentioned.
And then I guess you're also -- this is more mechanical, but you're also going to get, I think, a big uplift given that I think you did a lot of your share repurchase toward the end of Q1. I think you'll get most of the benefit of that into 2Q, and because it was such a large number looks to me like your share count should be going down by 8% to 10% sequentially. I think, is going to be another big near-term driver. Does that sound right to you in terms of the -- because I know when there's a net loss, there's also a lack of dilution in the current quarter. I wanted to make sure that I'm not missing some piece that might show up in diluted share count that wasn't in the share count this quarter.
The ASR that we announced on March 20th, we took -- we typically take 80% of the shares delivered upfront. And yes, given that was on March 20th, that's going to be in full effect that reduced share count is going to be in full effect for the second quarter.
You're right. The share count, went down like 7.1 million shares to 77.7% on Page 9 of the supplement, so the share count did go down materially.
And then thinking about your excess capital, can you just flesh that out a little bit at $650 million or so what -- is the vast majority of that at the holding company? What is the -- just remind me what the RBC threshold you're using to calculate that? And it looks like you have a lot of debt capacity. Does that include any of the debt capacity as well?
First, from a rating agency excess capital perspective, rating agency models only take into account capital in the operating companies. That's what we do here with the $650 million that we mentioned. It does not factor in cash at the holding company or potentially any excess cash. I'm sorry could you repeat the second part of your question?
Some people count debt capacity plus holdco cash plus life company excess and access, our definition of excess is only above rating agency thresholds in operating companies. We keep the cash at the holdco and debt capacity is additional levers.
Axel, would you change any of that?
Absolutely right.
And what's a reasonable base case to think about? And again, I'm just trying to level set you versus peers in the way that might define it.
We're running low to mid-teens on leverage. And for our ratings, you could easily run mid-20s. Now there is a point of we're positioning our balance sheet. As I mentioned earlier, we've hunkered down. We've got a lot of financials. If you look at excess capital in the life companies and the operating insurance companies, plus financial flexibility, we view the latter to cash at holdco and leverage capacity as additional financial flexibility. If you level set us with peers, that's the way I would approach it.
The next question comes from Dan Bergman with Jefferies.
Hey, thanks. Good morning. I guess, first, you saw a pretty meaningful sequential lift in the trendable yield. I think it was up 19 basis points quarter-over-quarter in the first quarter despite some pressure from the lower mark-to-market returns. I know you gave a little bit of color in the prepared remarks, but I just wanted to see if you could give some more granular detail on the components or drivers of that 19 basis point rise, including any quarter-over-quarter impact from Florida's higher purchase yields, mark-to-market assets or other items?
In terms of the work, so first, we've got purchase yields, right? We just talked about the very attractive new money yields and what we've been able to do in the quarter. Purchase yield added about nine basis points to taking fourth quarter yield and walking into first quarter. Nine basis points from there, about seven basis points from the increase in short-term rates on floating rate assets. And then net is about another three basis points of other stuff, which includes the negative on mark-to-market assets and then some normalization of investment expenses given some of the projects that have now been completed there.
And then also, I assume I heard it correctly, I think in the prepared remarks your commentary on quarter-to-date sales implies a step-up in the run rate of fixed index annuity sales, where they've been running. I just wanted to see if you could provide any more color on the drivers of the sales momentum. Is it concentrated in any particular products or driven by particular pricing actions you've taken. And just relatedly, I also wanted to see if there's any update you give on the competitive environment for FIAs. I know there have been also elevated competition earlier last year and then maybe it kind of rationalized more recently. Just want to see if there's any update you have there.
Through May 5th, sales of $600 million in the second quarter for FIAs -- we launched an AssetShield bonus product at the end of the quarter, somewhere in the latter half of the quarter, which has done very well. The receptivity to that has been very strong. It was a small hole in our segment of product portfolio that's done well. We're pushing on all cylinders. I've always said that this is a business of inches, not yards or miles, and you have to win it by inches, hand-to-hand combat. And then frankly, getting the AEL 2.0 story out to minute advisers get it, we then move them through the sales funnel. You get them hooked after 3 tickets and then you move them to 6 tickets and then you make them $2 million producers and larger, it's the ability to ramp that, but it requires discipline, execution and people knowing that we're profitability focused, but it's enough to go around for everybody.
And just in terms of competition, any changes you've seen from competitors' actions?
Some competitors have scaled back on rates. I think the 12% cap rates are gone, which is nice, and we're in the 10% to 11% range now. You've seen some cap rates come away. There are one or 2 very irrational competitors with 15% cap rates, which I don't understand, and I will not try to understand.
There is this pocket of irrationality, but more rationality and all the established ones that we actually compare ourselves with are great competitors to be with. I think the top 5, 6 drive everything, and there's some marginal new players that we're very cautious about.
And distribution who wants to go to the marginal players, God bless them and the others, we focus on the ones who want to be with us. Growing our advisers or agents that write multimillion dollars with us and stay with us because the time it takes for them to write an AEL ticket is a fraction of the time it takes them to write someone else's ticket. It is what got us the J.D. Power's #1 rating. Ease of doing business. Got as the Newsweek #1 rank of trusted insurer this year. There's a lot of positive momentum, but you have to sing for your supper, someone smarter than me one said that, and you really have to do that.
The next question comes from Pablo Singzon with JPMorgan.
Hi, good morning. First question, I just wanted to follow up on the ends are given by Axel on, the benefit from purchase yields in the first quarter. Is there any kind of season to think about with respect to purchase yields, whether amount of assets you end up buying in any given quarter. I guess more directly, any reason why that 9 bps benefit in the first quarter can or should not be extrapolated in future quarters?
Sure. Pablo, this is Jim. It's a function of different markets at different points in time, we'll have different levels of attractiveness. Sometimes we source assets in box, so we'll buy blocks of assets. But maybe week-to-week or month-to-month, it is certainly more volatile. But when you start thinking quarter-to-quarter over a 3-month period, generally, as markets move, it's fairly fluid, and we do have the opportunity across sectors to source assets. And so as we look forward, we see markets with great opportunities here. Now what those numbers will be, I don't know. But certainly, we expect to source assets across making both some equity and debt investments across commercial real estate across some across residential real estate infrastructure, middle market credit, agriculture. We see all those sectors as attractive, but we're being very diligent and we've been very careful in the actual assets that we're sourcing to make sure that we are buying assets that we'll be able to perform well through a cycle.
Everything Jim said is spot on. I'll add one simple way of thinking of how as we go to our internal investment committee and look at our private deals. Debt deals are getting done at equity levels from a couple of years ago and equity deals are very, very selective at this point. That's the way we are thinking about it. You can buy debt at equity levels, and you should.
And then my second question, this one, I'm sure it's for Axel. Just a quick follow-up on this. You can send a notable item this quarter. Was it mostly cash based? Or was there an equity component there that we should expect a recurrence of frequent periods?
Both components were in that number for this quarter and both components would continue to be in subsequent quarters, but to different extents. And again, as I mentioned, one component, the equity component is not essentially mark-to-market, so we'll be volatile that the expense associated with us would be volatile based on stock price performance.
I show no further questions at this time. I would now like to turn the call back to Julie for closing remarks.
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.
This concludes today's conference call. Thank you for participating. You may now disconnect.