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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Wilma Burdis - Credit Susie
Erik Bass - Autonomous Research
Pablo Singzon - JPMorgan
John Barnidge - Piper Sandler
Welcome to the American Equity Investment Life Holding Company Second Quarter 2021 Conference Call. At this time for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, coordinator of Investor Relations.
Good morning and welcome to American Equity Investment Life Holding Company’s conference call to discuss second quarter 2021 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 and Interim Chief Financial Officer and Jim Hamalainen, Chief Investment Officer. Some of our comments will contain forward-looking statements indicated by terms such as anticipate, assuming and believe continue to, estimate, expect forward, future, intend, likely, look to, may, need, over time, plan, potential, project, should, strategy, target, trends, will and would, our actual results could significantly differ due to many risks, including those 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.
Thank you, Julie. Good morning. And thank you all for your interest in American Equity. Before we speak about second quarter results, I want to provide you with three strategy execution updates. First, we reach agreement with Brookfield on a reinsurance contract that covers both a portion of our inforce and new business flow. We have filed the agreement with our regulator for approval. We look forward to receiving regulatory approval and closing on the reinsurance treaty. Shortly after, we would expect the second anticipated equity investment from Brookfield to be completed.
Second, we have completed our share repurchase of 9.1 million shares since starting a buyback in the fourth quarter of last year. This fully offset the impact of shares issued to Brookfield. The total buyback included repurchase of 3 million shares in the second quarter for $95.1 million. Additionally, for the first time in our company's history, in the second quarter, we started leveraging our asset management partnerships to invest in single family rental homes and middle market loans consistent with ramping towards the AEL 2.0 asset allocation strategy.
During the quarter, we invested in 933 single family rental homes, AEL will indirectly be the landlord to residential renters, with partners who manage the property through acquisition, renovation, leasing and sale in focus metropolitan areas where the trends of wage growth and rental growth dynamics are robust. During the quarter, we allocated $104 million to middle market loans. We expect middle market credit to be an important piece of the AEL 2.0 investment strategy.
Finally, we've continued the revitalization of our go-to-market strategy pillar, which has historically been an industry leading at scale, annuity funding origination platform. This platform slowed down in recent years and one of the focus areas in my first year as CEO wants to revise sales by refreshing our product mix and how we go-to-market. Go-to-market has been trending upwards since the fourth quarter of last year. Preliminary estimates indicate that the second quarter of 2021 will mark the third straight quarter in which the company increased its fixed index annuity or FIA market share. At American equity life FIA sales were driven by the new competitive indices we introduced to asset shield back in February.
At Eagle Life, the increase in FIA sales was driven by new relationships, our new income product and an increase in our employee wholesaler force. In addition, on July 21, we announced to our independent agent distribution, the introduction of a new product is state shield. The state shield is an expansion of our income offerings in the non-guaranteed income space. This sub-segment of the market is a $4 billion per year product space historically dominated by two of our competitors. The state shield has received strong support from key distribution partners and we look forward to growing sales in the coming quarters. We are committed to continue to introduce new products as we move through the AEL 2.0 transformation, which will help us compete effectively and grow our share of the annuity market.
Moving on to business results for the second quarter, total sales of $1.2 billion were down sequentially as expected versus the all-time record we set of $2.4 billion in the first quarter of this year. As we discussed on the last call, we are focused on our fixed index annuity products. For the second quarter, FIA sales increased 33% sequentially to $887 million.
As I said earlier, we believe this will be the third quarter in a row in which FIA market share increased. Clearly, the changes that we've made in our go-to-market franchise over the last year are resonating with distribution. At American Equity Life, fixed index annuity sales increased 36% to $703 million from $517 million sequentially as the refreshed asset shield series continued to see increased momentum led by sequential 206% increase in asset shield deposits.
In the quarter, the three proprietary indices we introduced to asset shield as part of our February refresh, the Credit Suisse Tech Edge Index, the Société Générale Global Sentiment Index, and the Bank of America destinations index accounted for 77% of second quarter asset shield deposits. FIA sales at Eagle life of $185 million represented a 24% increase versus the first quarter of 2021 and a 155% increase compared to the year ago quarter.
Our new Eagle select income focus guaranteed retirement income product accounted for roughly half of the sequential quarterly increase. The Eagle Life team is increasing our presence within distribution partners by updating our FIA product shelf and increasing our sales force headcount while raising the quality of talent. In addition, we are leveraging relationships with advisors and our distribution partners centers of influence uncovered through multi-year fixed rate annuities to migrate towards fixed index annuities.
As we indicated on past calls, our plan has been to reengage with distribution with a simpler multi-year fixed rate annuity product during COVID-19 and then pivot to driving growth through a revamped fixed index annuity product portfolio. We are beginning to see our plan bear results. As the financial planning needs of Americans evolve. American Equity is focused on providing our clients the dignity of a paycheck for life.
I believe our commitment to this core mission statement will become recognized and appreciated in the market over time. This will help grow AEL in both our channels and open up other market access opportunities for us in the future. At this time, I would also like to take a moment and share with you the conclusion of a Corporate Governance Project undertaken by our Board of Directors. Earlier this year, our Board retained nationally recognized expertise to review its structure and operations and to advise it on governance practices. The Board has completed its review and is implementing changes to refresh our corporate governance in line with best practices and to advance our strategic evolution. The Board has set a new target size of seven to nine directors plus the CEO has set a new director retirement age at 75 years and has modified the membership and structure of its committees. Importantly, on this front, our audit committee will exercise increased risk management oversight. The Nominating and Corporate Governance Committee will have an expanded role in director compensation, selection and skills training. The Compensation Committee will have a deeper role in executive talent development and succession planning.
We believe these changes will make our Board even more effective in driving stakeholder value realization and in playing its essential role in the successful transformation of the company.
Now, I'll turn the call over to Jim Hamalainen, our Chief Investment Officer before I come back to cover financial results.
Thank you, Anant.
Capital markets showed strong performance in the investment portfolio performed as expected in the quarter, the overall credit quality remained strong with an overall rating of single A minus for long-term investments. The net unrealized gain position improved by $1.2 billion in the quarter ending at $4.8 billion. The strong bid for assets, combined with low Treasury yields continues to make the investment environment challenging, but we are finding good opportunities.
We use the strong bid to continue to reduce exposure to higher risk positions in structured assets and select sub sectors that have the potential for future deterioration. There were minimal credit losses in the quarter, and the performance of our commercial loan portfolio remains strong with no new delinquencies or forbearances granted. From a liquidity standpoint, we continue to hold cash in excess of target levels, and what's needed to fund the reinsurance transactions.
At June 30, we held $10 billion of cash and equivalents in the insurance company portfolios. As Anant will discuss in a moment, the average level of cash and equivalents increased in the second quarter. The current point in time yield on the portfolio, including excess cash is still approximately 3.3%. So the pressure on investment spread will continue into the third quarter. After completion of reinsurance transactions and the redeployment of remaining cash in excess of our target, we estimate the yield on our investment portfolio would still have been approximately 4%.
With regards to redeployment, we expect to have substantially redeployed excess cash that's not expected to be used in the reinsurance transactions by year end. We are taking solid steps in execution of our strategy to add $1 billion to $2 billion in privately sourced assets this year, growing to a pace of 5% or greater of the portfolio on each subsequent year to achieve an allocation of 30% or greater in privately sourced assets.
Year-to-date, we have allocated approximately $800 million to privately sourced assets including residential mortgage loans, single family rental homes, commercial mortgage and agricultural loans and middle market loans. Traditional fixed income securities continue to be part of our strategy to deploy excess cash. Our focus in the traditional strategy has been strong investment grade credits in the public, corporate and municipal sectors.
For the second quarter of 2021, the expected return on long-term investments acquired net of third-party investment management fees was approximately 4.15% compared to 3.74% in the first quarter. We purchased $1.1 billion of long-term fixed income securities at a rate of 3.3% and $569 million of privately sourced assets at an expected return of 5.67%. The privately sourced assets include the ongoing origination of commercial mortgage and agricultural loans, as well as residential mortgage loans.
Consistent with our long-term plans, we added privately sourced assets and new asset classes for the company, which consisted of residential real estate investments and investment in a joint venture that is sourcing middle market loans at attractive investment yields.
With that, I'll turn it back to Anant.
Thanks, Jim.
Now turning to financial results, for the second quarter of 2021, we reported non-GAAP operating income of $93.8 million, or $0.98 per diluted common share compared to $93.1 million, or $1.01 per share for the second quarter of 2020. Results were negatively affected by the transitionary effects I mentioned both today as well in the past, in particular the effect of cash in the portfolio in excess of target range and the level of operating expenses. However, strong index credits in the quarter boosted operating earnings through both a lower than expected increase in reserved for guaranteed lifetime income benefits and lower than model amortization of deferred acquisition and deferred sales inducement costs.
Average yield on invested assets was 3.51% in the second quarter of 2021, compared to 3.58% for this year's first quarter. The decrease was primarily attributable to a seven basis point reduction from interest forgone due to an increase in the average amount of cash held during the quarter. Cash and equivalents in the investment portfolio averaged $10 billion over the second quarter, up from $8.6 billion for this year's first quarter. Partnership income and other investments accounted for at fair value contributed an additional one basis points to yield compared to the prior quarter and eight basis points on an absolute basis.
The aggregate cost of money for annuity liabilities was 156 basis points down 2 basis points from the first quarter of this year. The cost of money in the second quarter benefited from 4 basis points of hedging gains, compared to 2 basis points of gains in the first quarter. Investment spread in the second quarter was 195 basis points down 5 basis points from the first quarter. Excluding non-trendable items adjusted spread in the quarter was 181 basis points compared to 187 basis points for the first quarter.
In line with yield, we would anticipate our investment spread to rise back to our expected levels, once the reinsurance transactions are completed and the excess cash is redeployed. The cost of options was up slightly to 147 basis points from 145 basis points in the first quarter of 2020, primarily reflecting an increase in the cost of options hedging our monthly point to point strategies due to the decrease in volatility over the quarter.
Monthly point-to-point remains our largest hedge strategy at just over 25% of notional. All else equal, we expect to see the cost of money remained relatively stable over the remainder of the year, should be used available to us decrease or the cost of money rise. We had the flexibility to reduce our rates if necessary and could decrease our cost of money by roughly 58 basis points, if we reduce current rates to guaranteed minimums. This is up slightly from 57 basis points, we cited on our first quarter call.
The liability for lifetime income benefit riders increased $34 million this quarter after net positive experience and adjustment of $29 million relative to our modeled expectation. The better than expected result primarily reflected the benefit from historically high equity index credits in the quarter, as well as positive renewal premium experience. Deferred acquisition cost and deferred sales inducement amortization total $101 million, $31 million less than modeled expectations due to lower than model investment spread and benefit from high level of equity index credits.
Other operating costs and expenses increased to $65 million from $56 million in the first quarter. Operating costs in the second quarter included $5 million of expenses associated with talent transition, post refinancing our existing AG33 redundant reserve financing facility later this year, we still expect operating expenses to settle in the high 40s million dollar per quarter area. As we become a new AEL, we will invest in upgrading our infrastructure and our intent is to quantify this investment spend for you in the future.
Total debt to total capitalization excluding accumulated other comprehensive income at the quarter end was 11.9% compared to 12.2% at year end, and 14.7% in last year's comparable quarter. At June 30, cash and equivalents at the holding company were in excess of our target by $330 million. Finally, we have $236 million of share repurchase authorization remaining under the current plan approved by the AEL board of directors in October 2020. Once the Brookfield form is approved, we expect to actively repurchase more shares to both offset any dilution from future acquisitions to Brookfield and to start on our plan of regularly returning capital to shareholders.
Now I'll turn the call over to the operator to begin Q&A.
[Operator Instructions] And your first question comes from the line of Wilma Burdis from Credit Suisse.
Could you just walk us through the mechanics of hitting the 2021 share purchase target of 250 to 300 million x the band dilution. We were definitely happy to see that you guys definitely finally offset the first deal, but just trying to think through how the second deal will play out.
As I noted earlier, we've completed our share repurchase of the 9.1 million, which fully offsets the first tranche. Brookfield is awaiting the Form A approval from insurance regulators. It's really their filing. And therefore we are currently paused and share repurchase is to avoid their current holdings from exceeding 9.9%. After that formal approval is received, we expect to retire all the shares to share repurchase or other means, and then start a regular capital return. So it’s really a function of timing, our intent has not changed, on the 250 million post offsetting the dilution, we have the cash at the holding company, as you can see, to put that to work.
Got it. I guess my question just kind of on timing, just because it seems like -- just thinking about how long it's going to take to kind of process the Form A. And then just, what a good quarterly run rate buyback is to kind of achieve that goal?
Yes, I rather not speculate on mechanics of capital return. But needless to say, we're hopeful that Form A is in the foreseeable future. And then it's really a function of execution. Your point is a spot on question, which is that if you're out of the market in the third quarter, can you get it all done in the fourth quarter? And that's really what we're thinking about.
Okay. Does it seem feasible right now to get it done in the fourth quarter?
There are means to do it, but I don't want to commit to it. But I would say my intent has not changed. Our intent has not changed, but there are means to get it done in the fourth quarter if needed. Yes.
Got it. I guess the other question if I can -- with another one, just the 65 million of expenses was definitely a bit high. I know you called out kind of the 5 million on talent transition, could you maybe specify the other kind of notables in there and just kind of talk about the timing to getting back to the high 40s?
Sure. So if you back out what you just mentioned, you're right. So the path back to the high 40s is really around our refinancing of our AG33 redundant reserve financing, we expect to complete that this year. And that will get us back to the high 40s. The other parts of it, it doesn't get you fully back to the high 40s. But the other parts of 1z, 2z is going through like as we're standing up new operations, we acquired a new team, we're building out things in investment structuring area. So we really see those things getting done and quantifying the investments spend that state, but that's what gets us back there.
Have you guys quantified the redundant reserve financing costs?
We have, but we are in a competitive negotiation. So I'd rather not show my hand of the news to you. It would be fair to say if you took the last quarter expense number. And you took out the financing cost, we would clearly be in the range you just asked about which is the high 40s.
And your next question comes from the line of Erik Bass from Autonomous Research.
Higher index credit score, nice tailwind this quarter, and they seem likely to continue to skip in more markets are, so maybe you can talk about what this could mean for your go forward earnings and capital.
I can start and I'd love to have Steven to add in. He's been looking at this for a long time, Erik, by the way, good morning. The higher index credit this quarter were very strong. The point I would highlight is that 25% of our book is these monthly point to point click a options. And those kicked in meaningfully for the first time this quarter. There was a little amount of them in the last quarter, but not much delay. So if markets are sustained at current levels, we should continue to see monthly point to point to kick in, because that's one once the market drops, it takes 12 months really to cure yourself to start to get payoffs. The market fell last March and April. Now this March and April, therefore those options start to kick off, those were worth over $200 million of index credit for us. So a lot of value from that index credit coming through. And that should continue, Steven, why don’t you add in?
Yes. Hi, Erik, this is Steven Schwartz, Head of Investor Relations. And Anant is right, if you want to take a look at the big difference between the index credits in our account roll forward versus the first quarter this year, it's really coming from monthly point to point and that kicking in whereas the first quarter of last year, which was terrible for the markets as COVID developed as run off. So that's where that is coming from. The question of what reserves or that should look like, yes, given current equity markets, we should continue to see a benefit, all else equal. And I want to caveat that because of course, all else isn’t equal, the third quarter is coming up, the third quarter unlock is coming up. And patterns will undoubtedly change.
The level of equity index credits, which should be a positive for the unlock, but there are obviously dozens of other assumptions that go into that. So with that caveated, yes, you would see what you were suggesting, but the unlock is there.
And just to give you a place to point to in our financial supplement on Page 10. I'm putting on my CFO, Erik. You see index credits over there and you can see -- how they were $777 million and there is $200 million of plus of click a month to month benefit in that so.
Got it. Thank you. I guess in addition to the amortization benefits, you also think of building account value with the higher index credits and that all else equal should be tailwind. Then, I think for your RBC calculation, the index credits factor into that so it's, I believe, a benefit to the RBC ratio is well higher.
Hi. It's Steven again. Yes. On both first a question with regards delivery. Yes, our policyholder funds under management because of the strong equity index credits are better than modeled that is a positive going forward for the increased LIBOR reserve as well. Again, with the caveat of the unlocking and potential actuarial assumption revisions in the third quarter. Yes, index credits as well or as we've talked about in the past do affect statutory results, and strong index rates do benefit statutory income.
And your next question comes from the line of Pablo Singzon from JPMorgan.
Can you talk about how fast you can revert to a portfolio yield of 4% from where you are now, I guess after the reinsurance, you'll close. Seems like reinsurance will ease up a decent amount of excess cash. But as he had mentioned, you have to reposition some of the cash into new investments, which personally you might take some time. So any color you can provide there? Thanks.
Sure, Pablo, this is Jim, thanks for the question. I moved into the CIO role earlier this year and one of the first things Anant me to do was to take a fresh look at our investment process, particularly focused around creating a process that's resilient through the market cycles, particularly in down cycles in terms of capital efficiency. We're working through that process. As you know, we did a lot of derisking late last year, some more in the first part of this year, as we work through the process, we expect to put substantially, all of our excess cash to work over the next six months.
Got it. And then second question for me, different topics. So, can you provide a bit more detail on maybe this for not more detail on the AG33, you're sort of financing. Is objective to get a lower rate or to reduce the magnitude of reserves being finance and does internal reinsurer, you're setting up play a part in your AG33 strategy?
Hi, Pablo. It’s a great question. It's not to get more financing, but to optimize the rate will get to a more market rate than we have the markets move in the favor of insurance, and we want to get that rate. But I think it's a good opportunity for me to sort of take this time and talk to you about [indiscernible], how do we think about -- how do we think about the reinsurance company and so there's also advantage to capital efficiency with both repurchase of private invested assets and benefiting from tighter ALM with a captive insurer. And so that will provide us the flexibility moving forward, in addition to the better rate.
[Operator Instructions] And your next question comes from the line of John Barnidge from Piper Sandler.
Most of my questions have been answered. But I was curious, is there a drop day for 3Q ’21 or 4Q ’21? We're at the reinsurance transactions don't close that. It would seem certain maybe elevated expenses leak into '22.
Hi, John. Well, we would expect the full benefit from the AG33 reinsurance transaction to really come in '22 because we're later in the year, I started call [indiscernible] Wilma. In her question of where that's on a quarterly run rate basis. I don't really think so. This is a function of let me sort of lay out sort of our prioritization. These transactions take time to do. Our prioritization clearly has been to complete the negotiation and contracting on Brookfield, which we finished that in June with the regulator. We need to get the Brookfield Form A down and the Form D down which is their reinsurance transaction, that is paramount. And then, the reinsurance financing those two were our priority transactions.
And then, we go with our captive reinsurance to the regulator. So I don't see any real risks subject to adverse regulatory approval, which I'm not going to comment on the regulators. But that gets done this quarter, early next quarter.
[Operator Instructions] And your next question comes from the line of Erik Bass.
You just took a part of it. Guess what the timing of the Brookfield and rere transactions and then how are you thinking about the Värde deal on the potential timing there.
Hi, Erik. I'm glad you got back in the queue. I saw your question got interrupted. Thanks for coming back. I think you've got this, you've got the sequencing, right? Brookfield, all aspects of it Form A, Form D that is really a cornerstone strategic partnership, we want to consummate, we are very happy with the way it has come together. I really wanted to share with you all the economics of it and how we think about it on a cash economics basis, but I need to get the regulatory transaction closed. Then we've got the redundant reserve financing and rere. And in terms of Värde the way, I would put it as, we are yet to finalize the final terms of that transaction with Värde and Agam and expect to update you on that post the completion of the first three. But it does not get in the way of us getting fully invested over the next six months like Jim mentioned after closing both Brookfield and rere because our reinvestment plans are not contingent on that. And we will always be vigilant on shareholder value realization. What is important for shareholder value realization is Brookfield AG33 refinancing and rere, Värde is literally -- it's important, but it's -- the first three are paramount.
Got it. But I guess to be conservative at this point, we should probably not assume that did kind of the 5 billion reinsurance agreement with them, occurs in the second half of the year and that capital becomes available.
That's a fair assumption to make. That is a very fair assumption to make. But I would say that rere freeze up capital for us as well and you may ask why. So the reason for that is, because with rere, we get into more ALM friendly jurisdiction. So our C3 capital on our non-MVA business, which is a high risk C3 three capital charge would be lower in a jurisdiction where you got the benefit for ALM. So from a capital release point of view, we have many alternates in place than Värde and that was the real benefit of Värde. I'm focused with this leadership team to creating sustainable recurring revenue streams, so that we can shift towards ROA, Värde or Agam were not core to that, they release capital, but it didn't create a revenue stream like Brookfield eight, it doesn't create a revenue stream like alternative assets do. And that's what we want to do. Hopefully, that gives you the right color.
Yes. That's very helpful. Thank you. And then just lastly, I don't know if you can answer this. But you now have the final agreement with Brookfield on the transaction? Are there any material changes in this versus the initial agreement in principle that we've seen?
What I will tell you, we were very pleasantly surprised with the final term. And you will really like them when we share them with you, especially as we bring a new business flow in the totality of the agreement. If they're a great partner, we look forward to doing many things with them over the years.
Your next question comes from the line of Pablo Singzon from JPMorgan.
So Brookfield has spun off, Brookfield [reader] [ph] shareholders something it has done in the past. It's other businesses. So aside from having a public currency, and I guess being able to raise capital directly, will this structural change have any implications for your reinsurance relationship with them?
The short answer Pablo is no. Brookfield has -- the question is probably best directed at them. But I would tell you BAM Re versus BAM is virtually the same thing BAM Re shares are exchangeable into BAM at any point. And what's most interesting to us with this partnership is their source of permanent capital with their balance sheet that's invested in this. And that's very important as we think of permanently sidecar vehicles. We're looking for permanent capital, we're looking to really cut out the sponsor based model, where sponsors raise funds from LPs and funds. And then that capital goes into insurance vehicles, but it's not permanent capital, right? Our model is take long-term funding liabilities with permanent equity capital and be the asset allocator or the brains of the ALM machine that brings those liabilities and assets together with differentiated asset allocation to the private assets that we're going into.
Brookfield is a great example of what AL 2.0 will be through the reinsurance transaction we did with them. And we're open architecture for investments, which completely differentiates us from every other sponsor and based insurer.
Got it. And then, from your comments, it seems like the Form A approval process and the reinsurance review, those are completely separate. But I guess based on your comments, you expected to get approval for both in short order. What's the basis for that outlook which was given that, I guess, Form A is Brookfield process and things like that's entirely separate from this reinsurance agreement you've had with Iowa?
Yes, it's a great question. We would view the two of those together Form A and Form D, because now the Form A makes them an affiliate, the Form D is therefore required. So it's sort of together. What makes us confident around it as well. We've reached material agreement amongst us as parties. We've got in front of our regulator, we have positive momentum in dialogue with the regulator. I can't comment on the Form A, it's Brookfield process, but we're well aware of how it's playing out. We're really waiting for a hearing date. Once we have a hearing date, we can be more definitive if it's -- late three q or early four q but all signs big signal to around that late 3Q or early 4Q is just a question I'm getting a hearing done and hopefully getting approval on it. I won’t judge, by the latter outcome but that’s the way I would guide you.
Understood, and then last one for me. Some other companies have given the expected impact of C1 changes. I was wondering if you could provide similar information for EO. Thank you.
Sure. This is Jim, we have taken a look at that. And our early estimates would be around a 20 point impact RBC for that.
At this time, there are no further questions. I will now like to turn the call back over to Julie LaFollette 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 does conclude today's conference call. Thank you for your participation. You may now disconnect.