Feb 26, 2009
Executives
Julie LaFollette – Director, IR Wendy Carlson – President and CEO John Matovina – CFO and Vice Chairman Ron Grensteiner – President of Life Company
Analysts
Randy Binner – FBR Capital Markets Steven Schwartz – Raymond James & Associates Paul Sarran – Fox Pitt Bill Dezellem – Tieton Capital Management Alex Krutov – Century Atlantic Capital Greg Eisen – ICM Asset Management
Operator
Welcome to the American Equity Investment Life Holding Company’s fourth quarter 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.
Julie LaFollette
Good morning and welcome to American Equity Investment Life Holding Company’s conference call to discuss fourth quarter 2008 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com.
Presenting on today’s call are Wendy Carlson, President and Chief Executive Officer, John Matovina, Chief Financial Officer and Vice Chairman 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 Windy Carlson.
Windy Carlson
Good morning, let me add my welcome to the call today to discuss 4Q08 earnings. I am welcoming you on behalf of the new management team, which – the good news is, is also the old management team of American Equity.
Ron and John and I are very excited about our new roles and responsibilities and we are looking forward to having a good ’09 here at American Equity. We had very strong operating results to report for the year of ’08 and good results for the fourth quarter.
Our ’08 year-end operating earnings were $75.2 million, which is a $1.35 per diluted common share. That is a record for America Equity, we have never had annual operating earnings that high.
It represents a 16% increase over ’07 operating earnings at $64.9 million, which was a $1.10 per diluted share. Our return on equity of operating earrings was 11.4%.
So overall a very good year in terms of operating results in an extremely difficult environment. Our fourth quarter results came in at $15.6 million or $0.29 per diluted common share that is down 8% from the same period in ’07 where our earnings were $17 million although the EPS on a diluted basis was level at $0.29 a share.
Those results are very good and reflect the fundamentals of our spread management that continue to improve throughout the year in the forms of increasing yields and containment of our cost of money. Our year-to-date spread of ’08 was 277 basis points and there again that is a record for American Equity.
It compares to 261 basis points a year and that 16 basis point improvement on $14 million of annuity liabilities translated into significant improvement in net operating earnings. In the fourth quarter, we would have had a record quarter of operating earnings, but some increase in DAC and DSI expense due to unlocking and John will speak to that in detail.
So, we are very happy with the operating results in a difficult environment. We do realize that in this time of financial crisis that balance sheet issues are paramount, our book value per share as of December 31 was $9.53 a share that includes a net mark-to-market impact and compares to book value a year ago of $10.94.
The mark-to-market effects all are available for sales securities that reflects marks of assets to values, which are in many cases irrationally low in light of the ill-liquidity and disorderly markets that we are operating in. A certain portion of that mark-to-market has been reflected as an other than temporary impairment that flows through as a realized loss in our income statement.
So far we have recognized for the year $65.6 million of other than temporary impairment that is net of the related DAC and tax adjustments. For the fourth quarter we’ve recognized $16.5 million in other than temporary impairments.
We reported our GAAP results on a preliminary basis because we continued to evaluate the OTTI rules as they relate to a block of securities, which continue to perform in accordance with the terms and which our analysis is even in a stressed scenario that we will recover all our, substantially all of our principal and interest on those securities. Yes, the OTTI rules require us to continue to examine whether we should be reflecting a realized loss that flows through not only our balance sheet, but our income statement on those securities, which in our mind reflects more of a problem with the rules than a problem with the security.
I think the important take away from that is that our book value per share will remain virtually unchanged regardless of the outcome of that decision. Another important number, a very important number for us is our RBC ratio, which remains steady at 345% at the end of December that is the same level it was at the end of September and represents a good and adequate cushion for us in terms of our capitalization as we look to continued growth in ’09.
We do anticipate growth in ’09. It is a very good sales environment.
The demand for our products continues to be very strong. Principal protection is very attractive in today’s market.
CD rates on competing bank certificates of deposits are quite low in this environment, which has always been a favorable factor for sales. A number of our competitors have reduced their sales targets, which means that they have unique opportunity for American Equity to pickup market share.
It capitalized on all of those favorable trends, we recently introduced a very popular new product that Ron will speak to here in a little bit. SEC Rule 151A was adopted, it doesn’t take effect until 2011, so we anticipate that ’09 and 2010 sales will be unaffected by that rule.
In addition to that American Equity and several other carriers have challenged that rule in court that litigation is on a very fast track. The briefing will be done in April the arguments will occur in May, so we should have a decision on that yet in ’09 and we remain pretty optimistic that we are correct and our legal assessment of that rule, in the fact that the rules should be overturned.
So, with that I will turn it over to John to give you more detail into the numbers and the results.
John Matovina
Thank you Windy and good morning everyone. Looking at a few of the particular items in the financial results.
First of all turning to net investment income a record quarter of $214 million, while the year-to-date yield is published and the supplement was I believe 6.20% the yield in the quarter was actually 6.28%. Our yields have been moving up through the course of the year as the new money has been put to work at higher rates than what our historical average rate has been.
We do have – so fourth quarter yielded 6.28% that does include about 5 basis points from non-recurring what may call pre-payment income on private placement securities principally and some early quarters we’ve had some prepayment income on our commercial mortgages, in this particular quarter it is related to private placement securities, but 6.23% would have been in excess of the quarterly rates for the preceding quarters and were at 6.20%. So, the investment yield continues to progress up and we continue to invest new money at higher rates then where the yield has been.
We did have about $1.4 billion of securities called in the quarter. They were called that the book-yield on those securities was 6.19%, the new money was reinvested.
In terms of securities, we got an average combined yield of 6.79% and that would have been on a combination of additional agency securities, high grade corporate bonds, and additional high grade mortgage backed securities. And I just remind everybody we only buy investment grade securities.
When you look at any of our published tables that show us with any below investment grade holdings those will be as a result of rating actions that have taken place subsequent to our purchase. We also had $83 million, $84 million of new commercial mortgages funded in the fourth quarter at a rate of 6.42% and I mean despite some of the network in the market these days of our commercial mortgages, commercial mortgage backed securities, the commercial mortgage loan portfolio at American Equity remains in very good shape and we are very pleased with our performance there and with the book of mortgages we have in the books.
So the emphasis remains on credit quality as it has been with American Equity from the beginning of time. Looking at the other side of the spread equation cost of money, fourth quarter was at 3.43% that is level with the third quarter of ’08, despite the fact that volatility in the common measure is the VIX has been quite high, we’ve been experiencing an acceptable cost of money consistent with our targets that is due in part to the fact that more and more money is going into our fixed rate strategy and also to the fact that we do have embedded in the option index strategies one strategy called the monthly point-to-point and those options get cheaper when volatility increases so there is natural counter balance in the portfolio of business and in particular that option historically has attracted a fair amount of business because it is the one index strategy that provides the opportunity for the biggest market return when you have very strong up markets.
We have changed some new money rates earlier this month. We increased a few rates they were somewhat small for instance we went form three in a quarter to 3.35% on our fixed rates and so our option budget would be adjusting upward accordingly, we have a couple of strategies where the rate decreases are going to take effect first of next week and so we were not – we are expecting those changes to be neutral relative to the cost of money other than budgeting for a 10 basis point increase on new funds.
DAC and differed sales inducements, the amortization expenses as Windy commented did increase in the fourth quarter due to unlocking that was about a $14.8 million effect, which would translate into $0.17 a share after-tax. We model all of our index annuities similar to fixed annuities and that we assume a level rate of policy growth that is consistent with – say the interest credited on a fixed policy, which as we have said many times the interest credit is what we translate into our option budget.
Of course as we all know the equity markets have not performed now for four consecutive quarters and so we have not been receiving the index credits or growth in the policy account values from index credits and that led to the decision that an unlocking was necessary at this point in time, I mean I would comment that the unlocking activity is substantially due to that factor. We have not been experiencing increased surrenders from our products or any other deviations in any of our other assumptions of a material way that would have contributed to the unlocking.
There has been – I know one of our competitors has had some commentary about MBAs in their product and others as well leading to increased surrenders. We have never had MBAs on our index annuities, which as you know make up well over 75% to 80% of our in force business.
So, we are not experiencing any debt issues relative to those kinds of forces it is strictly the lack of index growth in the products. Surrender charge income was up to $15.4 million, but that being said that really reflects more of change in the composition as opposed to increased surrenders.
When you look at our total policy outflows for the year they are going to be in the neighborhood of $1.2 billion probably about a $50 million increase from the prior year. So, not much change in the overall outflow, but more of those outflows were subject to a surrender charge and the fourth quarter would have been our highest amount.
Also though even at those levels the surrender gain income continues to be below what’s been including in our DAC amortization models. GAAP net income for the quarter was $4.2 million that includes the write-downs of $16.5 million that Windy discussed and also a $5.9 million positive impact from FAS 133.
FAS 133 is as we have discussed many times before the fact that the market value adjustments to the index annuities in both the asset and liability side don’t move in tandem and in terms of the write-downs, we do have an increase in the tax valuation allowance for differed tax assets other than temporary impairments are viewed as capital losses and in the tax code you can only deduct capital losses against capital gains. At present, if we were to sell those bonds the point to remember, they are just other than temporally faired and realized the loss, we wouldn’t have sufficient capital gains that utilize the tax benefit.
So the valuation allowance is required. When asset values return to more normal levels it is very likely we would see a reduction of elimination in this valuation allowance.
It will be able to demonstrate the ability to sell assets and capital gains and offset any capital losses that might actually be incurred. No losses on the commercial mortgages, we continue to employ very sound underwriting practices that we’ve talked about on numerous occasions and it include in a couple of those slides we post to our website each quarter.
Couple of the key tenants of though is to just remind you of the fact that we are requiring 25% cash equity in front of all our loans and we use valuation measures as measured by cap rates that are higher than what we typically see many of our competitors use and higher cap rate results in a lower valuation of the property and therefore a lower amount of money that we are prepared to lend and also provides a cushion from adverse circumstances as the market is experiencing today. In terms of mortgage backed securities none of the write-downs that we’ve recorded and put forth in this supplement relate to mortgage backed securities, but as Windy commented those are still being evaluated with several securities there.
The concentration of those would be in all day type securities that had the rating agencies take those ratings down from the AAA rating wherever they were at when the securities were issued and when we bought them to – and in some cases ratings as low as single fee and even a couple even lower than that. In terms of looking at the magnitude of what’s under consideration in our watch list that is published in the financial supplement, we’ve identified mortgage backed securities at 237 million of book value with market values of 169 million so that is essentially the universe of securities that is still under consideration.
I would be surprised if all of those resulted in a write-down, but that is the universe that pursue working cap at this time. Capitalization remains strong at $1.2 billion of total capital.
For the year, our notes payable decreased by $10 million that’s largely a function of buying in a significant portion of our convertible debt, we were to buy in just under $80 million of the convertible debt in many cases particularly in the fourth quarter as substantial discount. Offsetting those repurchases would have been an increase in funding under our bank line of credit, which was actually the source for several of those commercial or convertible debt repurchases.
The trade-off there is that we’ve retired debt in a 5.25 rate with – when replaced it with debt, which we have now fixed the rate for the balance of that loan-term, which the bank line of credit as a fourth quarter 2011 maturity and those rates have now been fixed for the balance of the term on the $75 million outstanding at between 2.3% and 2.4%. Adjusted debt to capital ratio is at 29% compared to 30% a year ago.
So still well within the range of what’s comfortable for the ratings that we have. Accumulate other comprehensive loss is up from $143 million at September 30 to $166 million at December 31 and of course that reflects the continuing decline in asset valuations.
We’ve actually had portions of our portfolio moving in opposite directions. The corporate securities and mortgage backed securities have experienced greater losses like everyone would recognize corporate spreads widened up significantly in the fourth quarter, but the agency securities, which have a higher correlation to the government securities have actually the loss on those is narrowed because of the market environment.
The watch list did grow a little bit, you know, excluding the mortgage backed securities we are actually down some from 283 million, 244 million, significant portion of those non-MBS securities continue to be preferred stocks and bond in the financial sector, which have some $62 million of unrealized losses. I have commented on the mortgage backed securities.
On the commercial loans we do not have any commercial mortgages on our watch list. I know many of you have listened to us through the years.
We have made the statement very proudly, no default, no delinquencies during the fourth quarter we did have our first experience with a mortgage loan, which we have now put into the fourth closure process and expect to have title to that loan sometime next month. We’ve done analysis, we have market intelligence performed on the net loan.
I think the underwriting principles that I referred to earlier have served us well in this case. The value that property continues to exceed our mortgage and we are expecting to be able to once getting titled recover our money without any loss.
So with that I will turn the call for the very first time to Ron Grensteiner, the new President of American Equity Life Insurance Company and let Ron give you some intelligence on what is happening in the market with our agents and sales.
Ron Grensteiner
Thank you John. Good morning everyone.
I am very pleased to be a part of the team and on this call this morning. On a personal note, I have been with the company since the very beginning and I have actually been with Dave Noble as far back as 1986.
So I guess you could consider me an old timer. And I am very excited to be in my new role here at American Equity.
Just to comment on sales, sales in the fourth quarter were $553 million, which is an increase of 4% from the fourth quarter of 2007, which were at $533 million. For the year, sales were up over 9% at $2.3 billion compared to 2.1 billion in 2007.
We are very excited about our prospects in 2009 for all the reasons that Wendy commented on early in the call, we have been very received by agents and marketing companies looking for quality products and great service and many of our competitors have been reducing their sales targets so it has been a pleasure to be out on the role the first couple of months of this year and been able to go out with good news that we are still hear and have a desire to grow in 2009. We’ve had a tremendous bump in our pending count in the last 30 days.
In mid- January our pending weeks are low of approximately 1,800 cases. As of today, our pending stands at 3,515.
As a comparison we did not break 3,000 pending cases all of 2008, and one year ago our pending was at 2,034 cases. The last time we saw our pending this high was actually in February of 2006.
One of the reasons for our spike in pending is due to a new index annuity, which we introduced on February 1, it is called the retirement goal. This is a product that we have worked on for a long-time and we are able to fill a niche that we didn’t have before and that is a high bonus on a ten year surrender charge chassis and now that we have been able to introduce it, we’ve been able to recapture some of those producers that we lost to our competition that did have that type of product.
It is been going quite well needless to say, this product has already accounts for 21% of our pending inventory and it has been out less than 30 days. Finally, another event that is generating a lot of activity for us is our million dollar producer forum, which is coming up next week.
This is the third year that we have held this forum, and for a producer to attend they need to have written at least $1 million in fixed annuity premiums in 2008. We have some excellent speakers in breakouts as lot who perhaps you have seen on public TV.
We call the IRA guru [ph] will be there as well as Bill Harris, he is a fairly well known insurance industry speaker, he is going to talking about the basics of annuity selling and plus we will have four of our top producers on the podium to kind of share with the group what makes them successful. We have, as of right now 340 producers registered compared to last year where we had a 178 producers registered.
If you count the agents guests and marketing companies who are going to be attending we are expecting north of 550 people, which is by far our largest conference yet. The nice part about that count is of the 340 producers a 196 of them or about 58% qualify to attend by writing in other companies products and so the reason I think that is pretty good news is we will have an opportunity to market to these agents and hopes of shifting their business over to American Equity.
So, we are – to sum it up – related up for 2009, we are travelling and spreading the good news of American Equity and continue to tour our quality products and our great service. And so with that I would like to turn the call over to the operator for questions.
Operator
Thank you. (Operator instructions) You have a question from the line of Randy Binner, FBR Capital Markets.
Please proceed.
Randy Binner – FBR Capital Markets
Hi good morning thank you. I guess the question on the SEC issue for Windy I think I heard that you are doing arguments in April and then there maybe similar activity in May.
I apologize, I kind of missed that progression, if you just run through that again and may be give us a little bit more color on how that is progressing if there has been other insurance companies and trade organization that have joined in that suit with a yell?
Wendy Carlson
Sure absolutely. We filed the law suit in January really within hours of when the rule was published.
Included in the suit initially is American Equity three other carriers and a couple of marketing organizations. We were successful shortly after that in getting the court to agree to hear the case on an expedited basis and so that was an important procedural victory early on that indicates.
In the meantime, the NEIC petition that in a separate law suit also opposing the rule and those two cases have been consolidated and there is not briefing schedule for all parties that includes the NEIC. There have been a couple of briefs filed by friends of the court at (inaudible) including an insurance agent and our – and some others.
The deadline for those briefs is coming up in April and it is this fairly short-term. The SECs brief is due I want to say April the 10th and we will be able a file a reply brief on behalf of the company and the petitioners and I believe that date is April the 16th and then we will have arguments before the DC court of appeals on May the 8th and at that point that the time frame becomes more open ended because the court can take however long it desires.
We believe that we will certainly have a decision from the court before the end of ’09 and we would be hopeful to have a decision by the third quarter.
Randy Binner – FBR Capital Markets
Excellent, couple of follow-up questions. Now that the NEIC has now joined and your cases emerge is there any legal expense benefit to that we should think about in the other expense line going forward?
Wendy Carlson
Well I like how you are thinking, but it isn’t going to work out that way. We’ve got our own counsel the NEIC has separate counsel and so I doubt very much that our lawyers who are excellent will decide that they should reduce their fees because there is more parties involved.
Randy Binner – FBR Capital Markets
Is there – you know we run the other operating expense line runs – it ran about $14 million a quarter, last couple of quarters. You know, what is the marginal legal expense now that we are in the first quarter, you have a better visibility into the case.
I mean how much marginal expense would you expect to run to deal with litigation?
Wendy Carlson
Well it will be a little bit faradic like all litigation is, there has been a tremendous amount of activity in the first quarter to get to filing of initial briefs, but it is important to remember that those expenses are being divided among some six or seven different insurance companies and so that really buffers the impact of those expenses. Second quarter there will be expenses associated with the preparation for the argument and then after that the expense will really take our office, we just simply wait for decisions.
Randy Binner – FBR Capital Markets
Okay and then lastly is there any feel on the new SEC leadership or how that may affect the case, has there been any shift there?
Wendy Carlson
Yes. I don’t know how that will effect the case certainly Mary Schapiro took over within just days after this rule was published, which I think continues to call it a question the timing of the rule and the last minute nature of this initiative on behalf of the old administration at the SEC.
Mary Shapiro has been in overall and now just a short time. She has got a big job in terms of reestablishing the cloud of the organization from an enforcement standpoint.
So, I don’t know to what extent this particular issue has risen to a point of priority, but now that the rule has been published there is lesser opportunities to have dialogue with the SEC about compromise or about changes that might be more palatable to them, the industry. Now really to fight is in the court system and the new leadership has to work through their counsel’s office to go through that process.
And we are continuing our congressional strategy of seeing if we can get federal legislation introduced that would also have the effect of overturning the rule that either one of those things involve any direct dialogue with the new commissioner or the SEC commissioners.
Randy Binner – FBR Capital Markets
Alright thank you for the caller. I will drop back in the queue.
Operator
Your next question comes from the line of Steven Schwartz of Raymond James & Associates. Please proceed.
Steven Schwartz – Raymond James & Associates
Hi good morning everybody.
Wendy Carlson
Hi Steve.
Steven Schwartz – Raymond James & Associates
Hi. If I can follow up, I know Wendy you guys don’t what to give guidance, but can you just help us out with the legal expense and kind of what we might be – should be thinking about for the first quarter and the second quarter associated with 151?
Wendy Carlson
It is very difficult to give you guidance on those issues because in some cases we haven’t seen growth coming through for the time spent from us – from the law firms working on this. However the fourth quarter of ’08 was a very big quarter of activity.
In the time end process and working through the administrative side of this and so there was a significant amount of expense related to – against Rule 151A in the fourth quarter. And first quarter is not done yet, I haven’t seen the bills, but I am not anticipating a significant increase in legal expenses associated with this particular issue in the first quarter.
Does that help?
Steven Schwartz – Raymond James & Associates
Okay. Just as enter side, I don’t think, don’t remember John mentioning it, but they were severance expense as well in the fourth quarter, where there not?
John Matovina
I did not mention it, yes. But there was – as everyone knows Ron did a new role, he replaced Kevin Wingert who has been on this call for many years with us and in connection with Kevin’s operation from the company there was an agreement with him that provides compensation.
That agreement was filed as an 8-K quite some time ago and the full cost of that is expected. The present value of those payments was accrued as the liability in expense of the fourth quarter and that’s for the tune of about $670,000.
Steven Schwartz – Raymond James & Associates
Okay. And one more and I will get back in the queue.
Going back to legal, Windy is there any update on what’s going on in California?
Wendy Carlson
It’s been very quite for the last several months. So, there has really not been any movement forward or backward in those cases to speak off in the last three months.
Steven Schwartz – Raymond James & Associates
Okay great I will get back in the line.
Operator
Your next question comes from the line of Paul Sarran, Fox Pitt. Please proceed.
Paul Sarran – Fox Pitt
I have got a question related to the DAC unlocked, my question is if all industries back in DAC annuities perform at expected levels from where they sit currently will there bee a DAC unlock in 2009?
John Matovina
If they perform at expected levels?
Paul Sarran – Fox Pitt
They all return that the levels assumed in the DAC calculation from where they are now, which is generally down on the year.
Wendy Carlson
If we start to see increases again and start to account growth again, I think is his question John.
John Matovina
Well if the index is starting to perform from the current levels. I mean the index credits and the policies are calculated from one year to one year.
So, I am not sure you are asking a question the way it has been looked at. What I would say is DAC unlocking is an evaluation that happens at every quarter.
All quarters don’t produce an answer that says you have to do DAC unlocking. One of the elements of the analysis is always – are the account values growing at the anticipated rates.
Part of our consideration to do that unlocking this past quarter was the fact that we had had several quarters that the account values had grown because of lack of index credits as we look to the 2009, we had a high degree of certain degree that we were going to have pretty much one for sure perhaps two quarters where account value growth was not going to be at levels and so there was nothing to tell us that we could expect. The short falls that had occurred over the last several quarters to be replenished are made up to index growth in the near-term future.
Paul Sarran – Fox Pitt
Okay so just to approach it from another direction, where we sit now, would you expect the comp value growth in the third quarter or ’09?
John Matovina
The third quarter, you know the market – there is a possibility yes, there will be – I can’t say I expected, but I haven’t ruled it out at this point in time.
Paul Sarran – Fox Pitt
Okay:
John Matovina
If you are saying if the S&P closes or stays in the third quarter at the same rate it is today that probably means that there won’t be very many index credits of any at all from an equity option. Because many of the resets in the third quarter would be at levels – I mean you are talking about an S&P today that’s at what it’s lowest level and it’s tax number of years.
So, the third quarter policy reset would clearly have been in levels higher than the current index level.
Paul Sarran – Fox Pitt
Great. Okay I have a follow-up question on the OTTI, can you tell us how statutory impairments on the year compared to OTTI taken under GAAP, are they same or not?
John Matovina
For the amounts that had been recorded and reported in the supplement statutory and GAAP and none of those amounts relate to mortgage backed securities. They relate to corporate bonds or preferred stocks.
And statutory and GAAP have been, I want to say identical, I may tempo myself and say virtually identical, but they are awfully close but they are not identical. With respect to the mortgage backed securities that are under consideration there would not be any statutory other than temporary impairments.
The impairment rules in statutory for these mortgage backed securities are not as difficult as they are in GAAP. So if an additional way to develop it would not impact the statutory capital that – and the RBC ratios that were commented upon.
Paul Sarran – Fox Pitt
Okay. And can you provide the statutory adjusted capital at year-end and the required capital at the company action level?
John Matovina
The statutory capital in surplus is about $984 million and there is about $25 million or $30 million of AVR, $28 million. So that would translate into adjusted capital of about $1.011 billion.
And if you were to divide that by 3.45, you would get the required capital at the company action level, which is twice the amount of an authorized control calculation.
Paul Sarran – Fox Pitt
Roughly going to $295 million.
John Matovina
That sounds like it is in the ballpark. It has been a week or two since I have looked at that number.
Paul Sarran – Fox Pitt
Okay. And you are still targeting 300% for the rating agencies?
Wendy Carlson
That would be the minimum for the A-excellent rating that we carry.
Paul Sarran – Fox Pitt
Okay. Thank you.
Operator
Your next question comes from the line of Bill Dezellem of Tieton Capital Management. Please proceed.
Bill Dezellem – Tieton Capital Management
Thank you. A couple of questions; first of all, to make sure that we understand that the unlocking issue, and I apologize for beleaguering this, but you said that is due to slower account growth, and would you walk us through why the slower account growth impacts the level of DAC amortization please?
John Matovina
Sure. DAC amortization is one comprehensive projection model that as – first you start off, all you have is a projection of what your business is going to do.
As you have actual experience, the initial projections are replaced with the actual experience. The two key elements that have the biggest influence on those projections are got to be the spreads that are assumed, which as we discussed is very much within our control, because of how we separate, how we invest money and then the account value growth and it is a function of – you earn a spread on a particular volume of money.
The volume of money is projected to increase at the rate that is credited to the policyholders. So what has been happening here is valuating our future projections, we see that the volume of money that is expected to earn this spread has varied from our assumptions we had a year ago, actually revised assumptions we had in the second quarter.
And we have a shortfall. Our actual account values were several hundred million dollars less than the projected account values.
And so if the adjustment is made to replace those projected account values with the actual and in effect, re-project out all of your future growth prospects on the business. Now what translates into and helps making the adjustment as sizable as it is all DAC is done on what they call a retrospective method.
So what we have done is revised our projections of future income, but then to consider DAC, we have to recalculate as if we knew all that and the day we started doing DAC. So this retrospective concept takes into consideration your historical experience, your revised future projection to give you a new answer and then you adjust the DAC to where that new answer says you should be today versus where you are.
Bill Dezellem – Tieton Capital Management
That is helpful.
John Matovina
Hopefully that was. There is Ron shaking his head at me here.
But I hope that was simple enough for the audience to understand.
Bill Dezellem – Tieton Capital Management
That is what exactly what we were looking for. So thank you.
And continuing down a couple more accounting paths here; number one, the income tax increase that you accounted for in your operating income of $0.29. So that is not something that we should be thinking about as adding on top of the $0.29 if we are wanting to get some sort of special operating number.
Correct?
John Matovina
The income tax increase is actually a sign to the realized gains and losses. So you should not add it to operating income; the income taxes relate to the realized gains and losses or the valuation allowance.
Bill Dezellem – Tieton Capital Management
That is already in those two columns on your operating income page.
John Matovina
Yes. That tax increases going with the item of income that gave rise to those circumstances.
And it is the issue of – in tax return, capital losses can only be deducted against capital gains and because of our situation, we don't have any of what they call – the tax play strategies available to us have been exhausted. A typical one would be to carry the losses back.
While in our carry-back period, we don't have any capital gains available for offset, so we can only look to the future. And of course it is difficult to establish with – to meet the standard that is approved that it is more likely to not – you could generate capital gains to offset those losses if they were realized.
The important thing to remember though, I think from an economic standpoint is – we are talking about a lot of accounting here. First of all, the capital losses for the most part have not been realized.
Second of all, the danger of losing that tax deduction does not happen until you realize the losses. And that will start a five-year clock on a capital loss carry forward period.
So we're dealing with accounting rules here and not realities of has the book value of the company shareholder’s equity been really impaired by this tax increase.
Bill Dezellem – Tieton Capital Management
That is helpful. And then as we think forward to the first quarter, for example, since you now have your DAC retroactively and prospectively accounted for more accurately, given the lower account values.
But it seems as though all of your things being equal, we would take the $0.29 of operating earnings that you reported and add back the $0.17, hence leading us to $0.46 of earnings although the things being equal as we move into the first quarter.
John Matovina
That $0.17 is a negative adjustment on the $0.29. So your math is right there.
I pointed out I think talking about the five basis points of investment income in the yield, the 623 to 628, so that is an item there. Viewing going forward would be the opposite of that add back for DAC.
There is one other item of about $2 million on supplementary contract interest that was favorable to us in the quarter that would not be expected to occur. So there are some smaller amounts that are helping us in the quarter.
I don't necessarily think $0.46 is the baseline for our future projection, but certainly the income for the quarter would have been $0.46 without DAC unlocking.
Bill Dezellem – Tieton Capital Management
Understood. And maybe another way to look at it is $0.29 is also probably not a correct baseline, it is something higher than that.
Although as you point out, lower than $.46.
John Matovina
Right.
Bill Dezellem – Tieton Capital Management
Okay. Off of the accounting and I apologize for taking so much time here.
But if we look at the company, at what point is the share price so low that it is actually appropriate to slow your sales growth and take that capital and actually repurchase your converts and actually buy back equity? In fact, where that would be more advantageous to building shareholder value than actually building the business as one might normally do?
Wendy Carlson
Over the long haul, the shareholder value is unquestionably going to be enhanced by continued growth in the annuity business. This present market that we are in is so irrational that it seems very imprudent to be buying back equity even at these prices, just because we don't know what the future holds.
Other than that, it is a very good time for sales of our products and the opportunities for growth and continued spread earnings on that growth is there. So we – as John commented – we have repurchased some blocks of our convertible debt at very attractive prices.
We're looking at strategies that might involve being able to take advantage of the continued depressed price in that convertible debt. But our analysis would be that shareholder value would be enhanced by the continued growth of the company, notwithstanding the very low levels of stock price that we are seeing over the last couple of months.
Bill Dezellem – Tieton Capital Management
All right. Thank you.
And then finally, what is the average size of your commercial mortgages?
Wendy Carlson
The average size per loan is $2.7 million, if I remember correctly.
John Matovina
It might be a little lower than that. It is $2.3 billion diversified over 950 loans.
Bill Dezellem – Tieton Capital Management
Okay. That is the calculation that I did and I wanted to make sure that it wasn't missing some piece of the puzzle.
Thank you both.
John Matovina
Okay.
Operator
Your next question comes from the line of Alex Krutov of Century Atlantic Capital. Please proceed.
Alex Krutov – Century Atlantic Capital
Good morning. The question I planned to ask you has just been answered, but I have a follow-up to a question that has already been asked before.
The product indexed annuities has been very good for the company in the sense that it has allowed it to grow relatively rapidly. This is why the adoption of the SEC rule 151A, which classifies the product as a security is so important to the formulation of future plans for the company.
The lawsuit you have filed is certainly the right move, but I am wondering what plans you have for the future in case the SEC rule 151A is not overturned. In particular, because you utilize independent agents who for the most part cannot and don't sell security products and are even more difficult to educate than captive agents.
And I am sure you have formulated good contingency plans, I am just wondering what details you can share with us.
Wendy Carlson
Yes, that is a very important question, because you are quite right that not only do we have a legal strategy, but we have got a business strategy that we are pursuing in case Rule 151A becomes a reality. And that really involves activity in several different areas.
We have a broker dealer that has been in existence at the shell for ten years. We are making that operational, so that our broker dealer could be two things one, the wholesaler for marketing registered products as well as being the broker dealer, where a certain number of our agents could be associated as registered reps.
In addition to that, we are working with other broker dealers to establish affiliations that would allow us on a full-sailing basis to continue to market registered products through those other broker dealers, including those broker dealers where some of our existing agents would be associated as registered reps. At the same time, work has been going on for some time on a registered product.
We would anticipate filing that product probably in the second quarter of this year. We have given an awful lot of thought to what that product needs to look like in a broker dealer channel and it how it needs to be different from our existing products to be successful in that different distribution channel.
So there is a lot of activity on a lot of fronts there and we are very committed to making sure that that effort is not wasted, so that even if 151A does not become a reality that we see this as an effort towards diversifying our distribution, diversifying our product and really being an add-on to our existing business rather than supplementing or rather than replacing our current indexed annuity sales. One other aspect of that is that there are certain number of agents who just aren't going want to get license to sell securities.
They are going to want to be registered reps. They are going to want to change the form of their business in the very dramatic ways they would have to change in order to sell into this environment.
So we're very sensitive to the fact that there is a certain number of agents and estimating how many is very difficult, but a certain number of agents who are going to want to simply continue to sell traditional life insurance products and fixed annuity products that are not subject to the new rule. And so we're taking a variety of steps to enhance our product offerings in the traditional fixed side including a fixed version of the new product Ron spoke to a little bit ago that has picked up so much momentum in our market right now.
So that I guess in a nutshell are the various things we are doing.
Alex Krutov – Century Atlantic Capital
That is great. So I guess at least part of the plan is potentially diversifying into the products that you haven't previously focused on, even though you have some sales such as traditional life and life products.
Wendy Carlson
More traditional fixed-rate annuities as opposed to traditional life insurance products. From time to time, we evaluate traditional life insurance products and I'm not saying we would never go in that direction.
Right now, the focus would be on traditional fixed annuity products.
John Matovina
As a kind of add to what Wendy commented on there; you know, the indexed annuity has been the main product that we sell but in my comments I think I made the fact that there is a fair amount of money in index annuity that gets allocated to the fixed-rate strategy. And in fact, I think a lot of our sales and indexed products are people who really only want a fixed product but they are buying the indexed product because it has features up until what is going to happen soon.
It has features that the traditional fixed products didn't have and those features were principally a high premium bonus, and something called a lifetime income benefit writer that has been in existence for about the last couple of years. And it has only been used with indexed annuity products.
Come April 1, we will have a new traditional fixed-rate product that will have a bonus level that is comparable to the bonus levels in one of our indexed products and we will also have a lifetime income benefit writer available to us. So I think we are probably see some of the sales that have been going to our indexed products because of the attractiveness of the bonus and a lifetime income benefit writer will end up in this traditional fixed product, because they will now have comparable features without the opportunities for indexing.
Alex Krutov – Century Atlantic Capital
Thank you. That sure answers my question really well.
I have one more kind of quick question. You have mentioned that you haven't had losses on any of the commercial loan portfolio elements, none of those loans.
Do you have some kind of a variation allowance for the whole portfolio, even though you do not have specific reasons to worry about any individual loan?
John Matovina
No we do not and that subject is discussed among ourselves periodically. It is discussed with our auditors, obviously annually as part of the audit.
Our premise has been – up until the loan I described earlier, we have never had experience where we have actually had to go through a foreclosure proceeding and now I think we are into our eighth or ninth year of being in the commercial mortgage business. And one of the reasons we believe that – the reason we believe that is because of the discipline and the underwriting practices that have been employed from the very beginning to not underwrite – to risk your situation.
I have heard it discussed before that some companies in their commercial mortgage programs will have a mindset that they are going to price strategize for a certain level of expected defaults. And we have that too.
Our expectation is zero, and that is how we – that is how we underwrite. We have had several presentations where Bob Kunnen, who heads our commercial mortgage area has spoken very directly to the fact that – he has been in the business for quite a few years, going back to the ‘80s with the predecessor company, and the practices that he brought to American Equity were developed around times when commercial mortgages were in great stress.
So the practices have been set up to deal with environments that we appear to be entering in today. That doesn't mean that we are going to have a loan or to or several that we have to come to grips with, individual situations.
But nothing has risen to the level yet where our general loan-loss allowance would be something that would be necessary for American Equity.
Alex Krutov – Century Atlantic Capital
Great. Thank you.
And congratulations on your promotions.
Wendy Carlson
Thank you.
Operator
You have a follow-up question from the line of Steven Schwartz of Raymond James & Associates. Please proceed.
Steven Schwartz – Raymond James & Associates
Hey everybody. Hey John, when you were talking about DAC, it occurred to me, you should've described it as a very, very dark place.
Wendy Carlson
You are right.
Steven Schwartz – Raymond James & Associates
I'm not sure how many people would still get that. I got a couple of questions for Ron and then a couple of more financial questions.
Ron, Gold Eagle Producers, what was the number for the year?
Ron Grensteiner
Gold Eagle producers, we had about 560+ Gold Eagle producers last year, which is up by about 100 Gold Eagle producers from the previous year.
Steven Schwartz – Raymond James & Associates
Okay, very good. And then just looking at the fourth quarter numbers and the numbers that were reported by annuity specs the other day, it looked like you may have lost a little share on the indexed side.
Any thoughts on that?
Ron Grensteiner
I think annuity specs had the total market up about 12% indexed annuity.
John Matovina
I don't know if we lost ground or some of our competitors actually gained ground for the reason for that, Steve, so I'm not sure I have an intelligent answer for you at the moment. Our sales were very strong in the fourth quarter and as I indicated earlier, are doing quite well so far in the first quarter.
Steven Schwartz – Raymond James & Associates
Yes. Sounds like it.
Okay, and then, John, I don't know whether you are familiar with it, or how up to speed you are, my understanding and I may have it wrong, is that part of the administration's stimulus proposal is to increase the look back period for losses. I don't know if that would help you back, help you out, or if it includes capital gains and losses or just operating – I was just wondering if you knew anything about that.
John Matovina
Honestly no, I don't know what might be discussed there.
Steven Schwartz – Raymond James & Associates
Okay.
John Matovina
Obviously, for any benefit for us, it would have to be fair look back on capital losses, because we always pay taxes on our operating income and expect continued to have operating income on which we will pay taxes.
Steven Schwartz – Raymond James & Associates
Okay. That is what I had.
Operator
You have a follow-up question from the line of Randy Binner of FBR Capital Markets. Please proceed.
Randy Binner – FBR Capital Markets
Hi, thanks. Most has been answered.
And I apologize if we have touched on this, but there is a migration from available for sale that held the investment or held the maturity.
Wendy Carlson
All the way around.
John Matovina
Yes, all the way around, right.
Randy Binner – FBR Capital Markets
I mean – I am sorry. I got it the other way around.
Is there – what securities the involved there, and if you could just walk us through what happened there?
Wendy Carlson
With the declining rates, we have experienced a high level of calls in ‘08 and particularly in the fourth quarter though in the many cases were caused that of agency securities that were in that held for prematurity category. As we have reinvested those funds, the new securities have been categorized as available for sale.
So that is really what is happening there.
Randy Binner – FBR Capital Markets
Is there any contingent effect of that potentially on other things that sit and help the maturity?
Wendy Carlson
I am not sure.
Randy Binner – FBR Capital Markets
Meaning that if the portfolio was tainted or if that class of asset was no longer passed the held the maturity test.
John Matovina
The call of the security by the issuer does not taint the health of maturity classification or our ability to continue to use it. The tainting would occur if we did something to sell securities which we have not done.
Randy Binner – FBR Capital Markets
What is the outlook for those calls?
Wendy Carlson
Well, you tell is where rates are going and we will tell you what the outlook is. With the further decline in rates, we would experience potentially significant additional calls.
Randy Binner – FBR Capital Markets
Okay, fair enough. Thanks.
Operator
Your final question comes from the line of Greg Eisen of ICM Asset Management. Please proceed.
Greg Eisen – ICM Asset Management
Thanks, good morning. On the release you have mentioned your reinvestment rate for bonds; the fourth quarter is 679 and mortgage is 642.
Could you compare that to what your present reinvestment rate might be? Now or within the first quarter on average.
John Matovina
In the first quarter, so far we have purchased investments of about $1.2 billion to $1.3 billion, we have had some additional calls and those have been at a rate of 675. That includes a combination of – we have replaced some of called agencies with additional agencies, those at lower yields.
But we have had additional corporate bonds additional mortgage-backed securities spread across the BBB to AAA range, that result in a blended yield of 675. Our commercial mortgage activity and actually I forgot to put it on a piece of paper and bring it with me but from recollection of looking a few days ago, we have been funding loans at the 650+ range and probably even a little bit higher than that.
We have actually not had a lot of business or a load of closed loans in the first two months of this year from the commercial mortgage side. Our size of our commercial mortgages are relative to our capital or those that you saw that (inaudible) on us back in October.
They made a comment about the level of commercial mortgages to capital and so we haven't been as aggressive in the market on commercial mortgages, trying to build those as we have in the past. So yet our current rates are 675.
We're not closing as many loans as we have done in the past.
Greg Eisen – ICM Asset Management
I guess what you just said might answer my next question, which was should I read into anything into the year over year change in your balance sheet between bonds and mortgages and where bonds essentially the two categories together are relatively unchanged with (inaudible) and mortgage loans in total were 19% year-over-year from December to December. But I shouldn't read into that that you will have a similar relative proportional change in 2009 based upon what you just said about AMS?
John Matovina
That is correct. We will continue to be in the commercial mortgage market, but that level of growth would be on the outside of what would be reasonable.
Greg Eisen – ICM Asset Management
Got you. You bought back your convertible debt during the quarter.
Could you tell us how much was outstanding at the end of the year?
John Matovina
A little more than $180 million, about $182 million, just under $182 million.
Greg Eisen – ICM Asset Management
Okay. And I left the hardest for last.
If I may just be the dead horse here, one more question again about the DAC. If for instance, the market were to take off from here, and we would have a strong year, over the next few quarters in 2009, based the way the DAC amortization is calculated, first, I am assuming that means you wouldn't have an accelerated amortization versus your prior projection, where the projection is until December 31.
But secondly, in each quarter if you heard the market was very strong, would you revise your projection such that you would shrink the size of the amortization expense to be in proportion to what has happened to the account balances? If the account balances go up an awful lot in the next couple of quarters, will that shrink the DAC amortization or else be equal?
John Matovina
DAC amortization does work both ways, unlocking can be positive and negative and you have described a situation that could lead to what I would call a positive unlocking adjustment. You can't just look at one absolute factor though, but that certainly would be factors that would contribute to an adjustment, which positive from the standpoint of elevating income, reducing the amount of amortization.
Greg Eisen – ICM Asset Management
I understand. Okay, I get it.
And as far as the first quarter is concerned, this is just the end of February right now, but if we close the books on the first quarter today, the market on the equity side is down very hard. Would you anticipate at the current equity levels that you would see a further increase in your DAC amortization over and above what we saw in the fourth quarter because of the poor market performance?
John Matovina
Given the fact that we have done this unlocking as of December 31, even a poor equity market performance, which is virtually assured for the first quarter should not lead to another DAC unlocking at March 31. We have tolerance levels built into our analysis that says one quarter is not going to be sufficient to exceed those tolerance levels to say things we have gotten bad we have to unlock.
Greg Eisen – ICM Asset Management
I get it. Okay that was it from me.
Thank you very much.
Operator
There are no further questions in the queue. I would like to turn the call over to Ms.
Julie LaFollette for final marks.
Julie LaFollette
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.
Operator
Thank you for your participation in today's conference. This concludes the presentation.
You may now disconnect. Good day.