May 2, 2013
Executives
Julie L. LaFollette - Director of Investor Relations John Michael Matovina - Vice Chairman, Chief Executive Officer, President, Member of Executive Committee, Member of Disclosure Committee and Member of Investment Committee Ted M.
Johnson - Chief Financial Officer, Treasurer and Member of Disclosure Committee Ronald J. Grensteiner - Vice President and President of American Equity Investment Life Insurance Company Jeff Lorenzen
Analysts
Randy Binner - FBR Capital Markets & Co., Research Division Steven D. Schwartz - Raymond James & Associates, Inc., Research Division Mark D.
Hughes - SunTrust Robinson Humphrey, Inc., Research Division
Operator
Welcome to American Equity Investment Life Holding Company's First Quarter 2013 Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Director of Investor Relations.
Please proceed.
Julie L. LaFollette
Good morning, and welcome to American Equity Investment Life Holding Co.' s conference call to discuss first quarter 2013 earnings.
Our earnings release and financial supplement can be found on our website at www.american-equity.com. Presenting on today's call are John Matovina, Chief Executive Officer; Ted Johnson, Chief Financial Officer; and Ron Grensteiner, President of the Life Company.
Some of the comments made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied.
Factors that could cause the actual results to differ materially are discussed in detail in our most recent filings with the SEC. An audio replay will be available on our website shortly after today's call.
It is now my pleasure to introduce John Matovina.
John Michael Matovina
Thank you, Julie, and good morning, everyone. Thank you for joining us this morning.
It seems like just yesterday we were doing fourth quarter call, and in fact, the first quarter, I don't -- at the time we did that call, we were pretty much halfway through the first quarter, had a pretty good feel for perhaps how things were going to turn out, and they did turn out, I think, pretty much as we expected. Probably the only new thing that happened in the second half of the quarter was our decision to call in some convertible notes, which were indicated in the press release and I think Ted will talk about in his remarks.
So for the quarter, operating earnings were $33.5 million, that's $0.49 per diluted share, up from $29.8 million in the first quarter a year ago. Results for us continue to be held back by the low interest rate environment, as we commented about in the press release and in the last call we had, due to the high cash balances that we're holding from calls of government agencies.
And as we had indicated last quarter and in the press release, we did make some significant progress this quarter in putting some of that cash to work. That was aided by the fact that we didn't have much in the way of new calls in the quarter so that progressed as expected.
However, as we've commented in the release and in the last call, second quarter, we're likely to have an interruption of that progress because we have almost $700 million of bonds that have already been called that does in the call exposure, but that level of incremental cash is going to slow down the progress of reducing the overall balance. Our sales for the quarter were satisfactory at $930 million and contributed to a 3% increase in our assets under management.
The momentum of sales began accelerating in March, and it's looking to us like second quarter sales will surpass $1 billion, and Ron will, in his remarks, comment about the sales results and the competitive environment, give you a little more background as to why we have some confidence that, that $1 billion level will be hit in Q2. And with that, I'll turn the call over to Ted Johnson to talk about financial results.
Ted M. Johnson
Thank you, John. Investment spread for the first quarter was 2.68%, and total invested assets at March 31 were $29.2 billion, $26.6 billion on an amortized cost basis.
Invested assets will grow by an additional $285 million as we invest the temporary cash balance held at the end of the quarter. The spread result of 2.68% was 9 basis points more than the previous quarter's spread of 2.59%.
The average cash and other short-term investment balance during the first quarter was $1.8 billion compared to $2.7 billion during the fourth quarter of 2012. The yield on these instruments in the first quarter was 33 basis points compared to 32 basis points in the fourth quarter.
Partially offsetting the cost of liquidity was 7.5 basis points from prepayment income on commercial real estate mortgages and consent fees on bonds. In addition, we had 3 basis points of benefit from overhedging in the first quarter.
In comparison, we had 11 basis points of prepayment income and 3 basis points of benefit from overhedging in the previous quarter. The cost of money declined to 2.33% in the first quarter from 2.44% in the fourth quarter.
This decline reflects management's actions to maintain spreads by adjusting rates to policyholders. We will make further reductions in policyholder rates as necessary to restore our investment spread to the 3% target.
We have approximately 60 basis points of room to reduce fixed rates and rates on indexed annuity policies before minimum guarantees would cause spread compression. You can see the disclosure of this in the financial supplement on Pages 10 and 11.
During the first quarter, we purchased $2.3 billion of new fixed income securities at an average yield of 3.48%, and we funded $105 million of new commercial mortgage loans at an average yield of 4.32%. $1.3 billion of the security purchases were predominantly investment-grade corporate bonds with an average yield of 3.45%.
We also purchased $289 million of commercial mortgage-backed securities with an average yield of 3.67% and $345 million of government agency bonds with an average yield of 3.12%. During the first quarter, $250 million of government agency securities were called.
These calls include $200 million that had a book yield of 1.08% that were included in the year-end short-term investment amount. Our government agency bond call exposure for the remainder of 2013 includes $678 million of securities with book yields and coupon rates of 4% or higher that were called in April, an $18 million security with a book yield of 0.96% that was called in April and $509 million of securities with a book yield of 0.75% that are expected to be called in July based upon current interest rates.
The securities expected to be called in July were purchased as substitutes for cash investments and at a premium to par. If not called, as presently expected, their book yields would increase to 3.75% after the call date passes.
We also own $574 million of 15-year government agency securities with coupons and book yields ranging from 2.96% to 3.17%. $250 million of these securities will become callable in late December and $324 million will become callable in the first quarter of 2014.
However, based upon current interest rates, we do not expect these securities to be called. Operating costs and expenses were $19.5 million for the first quarter compared to $18.7 million in the fourth quarter and $21.7 million in the first quarter of 2012.
The increase from the fourth quarter 2012 is primarily related to an increase in compensation expense. The decrease from first quarter of 2012 is due to reduction in state taxes and fees and reduction in state exam fees.
Our book value per share excluding accumulated other comprehensive income of $16.84 is up $0.35 from the December 31, 2012 book value of $16.49. And our RBC at March 31 was estimated at 330%, slightly down from 332% at the end of the year.
We sent out a notice of a mandatory redemption for our 5.25% contingent convertible senior notes due in 2024 in late March. $25.8 million principal amount or 91% exercised their conversion right prior to the April 30 mandatory redemption date.
The conversions are net share settlement, which means the principal amount will be paid in cash and the conversion premium will be settled in shares of American Equity common stock. The final number of shares to be issued will be determined based upon the 10-day average closing price for American Equity common stock on the 10 consecutive trading days beginning on the second trading day following the date the notes were submitted for conversion.
As most of the conversions were not submitted until last week, the final number of shares to be issued is not known at this time. If the 10-day average closing price for each conversion was $15 per share, approximately 158,000 shares of American Equity common stock would be issued to satisfy the conversion obligation.
The remaining $2.45 million of the convertible notes was redeemed for cash of $2.5 million, which includes accrued interest through the redemption date of $50,000. We will use holding company cash and a draw on our bank line of credit to fund our cash obligations in connection with the conversions and redemptions of these notes.
With that, I'll turn the call over to Ron to talk about sales and production.
Ronald J. Grensteiner
Thank you, Ted. Good morning, everyone.
As John reported, our first quarter sales were $930 million. This is down slightly from our first quarter 2012 of $979 million.
If we look back in history for just a second, 5 years ago, 2008, our first quarter production was $518 million and 10 years ago, it was $314 million. It just reminds us how far American Equity has come over the years and during some pretty difficult economic times.
Today, we have more momentum going into the second quarter than we did a year ago. Last year at this time, our pending count was in the 2,900 to 3,000 range and going down.
Today, pending is at its highest levels for the year, and we're in the 3,300 to 3,400 range. It seems that the general attitude today is more positive than it has been in the past year from both a general public perspective and a marketing perspective, and our agents and marketing companies feel it and are projecting a better year.
We don't think that there will be any spikes, but it will be better. At American Equity, we're certainly optimistic, too.
We introduced 2 new benefits and an agent sales contest in April 1. The benefits we introduced are not new to the industry, but they're new to American Equity.
However, we don't consider ourselves a me-too company. So if we're not the first company to introduce something, we want to try and create some uniqueness or make improvements.
And one of the benefits that we introduced was an enhanced death benefit rider, and that is where we guarantee a 4.5% interest rate, which is paid out at the death of the contract holder. To get the 4.5% rate, the beneficiaries need to take a 5-year payout or if they want to take a lump sum, they can do that, too, but it'll be at a discounted value.
And of course, if the contract value is higher than the enhanced death benefit value, we pay that instead. There's a fee of 70 basis points if the customer or policyholder chooses to add it to the contract.
We also introduced a well-being rider, which doubles the lifetime income benefit rider payouts. And that's once the payout is actually in income mode and if the contract owner cannot perform 2 of 6 activities of daily living, we'll double, basically, the income payments for a maximum of 5 years.
And for this benefit, if they choose it, we have a 15-basis-point fee. And these are introductory rates.
We introduced these on April 1. We do anticipate some modifications on June 1.
While we're not the only company that's feeling optimistic, there have been some product introductions by other competitors. It seems that the more aggressive companies are not our long-term competitors like Allianz and Aviva.
It seems that most of our competition these days or I should say most of the aggressive competition are from companies that are new to the marketplace or companies that are considered, what I consider, in and outers. Basically, they get in the market with a hot product or a hot rate and then when they've satisfied their appetite for new sales, they pull back.
And what we're seeing today isn't really American Equity style as far as aggressive competitors. For example, we're seeing some new products introduced where they're reducing the penalty free withdrawal provision from a 10% down to a 5%, and that's gets them maybe a little bit more -- maybe a higher cap or a higher roll-up rate or something.
Or they're changing the roll-up rates on their income benefit riders from compound interest to simple interest so they can have a higher percentage to talk about. And we think we're also seeing some more exotic index crediting strategies.
So one thing for sure is American Equity is going to stick to our principles. We've been in the top 5 for index annuity sales 51 out of the last 56 quarters, so we must be doing something right.
And interestingly enough, over the last 8 quarters, there's been 5 different companies that have been ranked #4 according to AnnuitySpecs, and none of those 5 companies have managed to break into the top 3. We also had a successful Million Dollar Producer Forum this past March, where we had 300 Gold Eagle members in attendance.
And to refresh your memory member, a Gold Eagle member is somebody that writes at least $1 million of premium for American Equity during the calendar year. In addition to those 300 Gold Eagle members, we had their guests and office staff, for a total of 550 attendees.
I think it was our best program yet. We had many of the attendees tell us it was the best program yet.
The problem with that is we always have to improve it the next year, which, so far, we've been able to do, but we've got another one scheduled for next year again. What makes the program special is we have our top 10 producers make presentations on their business strategies and their sales practices.
And when we talk about our top 10 producers, these are producers that write $13 million and above over the last year, so these are very successful people. Our other agents want to hear what's making them successful and so they come.
And in addition to making presentations individually, they also sit on a producer panel where they'll take questions from the audience. We also have some outside-the-insurance-industry speakers, too, to talk about organization or maybe a motivational speaker, those types of things, so to kind of lighten the mood a bit.
So it's been a great program for us, and we're going to continue to do it. We have a very specific marketing plan, Kirby Wood and Jeff Risco [ph] and Jessica Kilker and all those people over in the marketing area have put together a plan to make sure we engage all those Gold Eagle members that we're at the Million Dollar Producer Forum.
We want to make sure that they become Gold Eagle members again in 2013. We have been successful in retaining Gold Eagle members from one year to the next.
Last year as an example, 58% of our Gold Eagle members were retained from the previous year. But we have more success for the top level producers.
So for example, we only retain 55% for those producers that wrote between $1 million and $2 million the previous year, but that number spikes up to 82% if they wrote more than $2 million for us the previous year. And it spikes again to 86% if they wrote more than $5 million for us.
So we really want to focus on those Gold Eagle members, and in particular -- we want to focus on all of them but in particular, the ones that write $2 million-plus. We're also having a Gold Eagle producer forum in our offices next week.
This will be the first Gold Eagle forum we have of the year. We have some other ones during the course of the year, where our marketing companies bring producers in.
But we're going to have 55 of our Gold Eagle members here. This is a chance for us to develop stronger relationships with these people.
They'll hear our story. We'll roll up our sleeves and get into the products and benefits and features.
They'll hear about our investment portfolio philosophy. And of course, they'll get to meet the people who really do the heavy lifting around here, and that's the team mates that keep this company on the go.
We're continuing our policyholder appreciation events. We're going to continue to do these.
They continue to work for us. We do them every month except March, July and November.
So far this year, we've been at Charlotte, Atlanta, West Palm Beach, The Villages in Florida, Houston in and Dallas, and we saw nearly 1,400 policyholders at these 6 events. And we think they're catching on because we've never had this problem before, and this problem is waiting lists.
We had waiting lists at 3 of the 6 events, and that's just amazing to me. So far, we've seen 11,500 policyholders and over 700 agents.
And my description of these events just doesn't do them justice, it's something you actually truly need to witness to appreciate. I know the policyholders feel better about their policy in American Equity after the event, and plus, it always commits -- recommits our home office staff after we go to these events because now we've met them, we've had lunch with them and we've engaged them and they're not just numbers, they're people, imagine that.
So we always go home more committed than ever to do the best job we can. As I mentioned earlier, we're optimistic about the future.
We feel this is a great time to be in our business. While the stock market may be up, it seems pretty fragile at times.
Yet, our index annuity policyholders can benefit when the market's up and still have that principal protection, minimum guarantees and lifetime income. In the first quarter, our average indexed annuity interest credit was 4.5% and the maximum for the quarter was 11.42%.
20% of our indexed annuity policyholders received between 4% and 5% in the first quarter, another 19% received between 3% and 4% and 15% of our indexed annuity policyholders received between 5% and 6%. So if you add it up, 54% of our indexed annuity policyholders receive between 3% and 6%, not too shabby for a safe-money-type product.
Last but certainly not least, our home office team continues to deliver excellent service to our agents and policyholders. I'm so proud of them as, I know, all of the senior management team is.
They do such an awesome job. I had a producer call me out of the blue the other day and for no other reason just to say thank you for delivering on our commitments.
He said our competitors won't or they can't. So when I look at our home office team and their longevity with the company, you can't help but be proud.
When I look at our statistics, 36% -- excuse me, out of our 400 employees, 95 of them have been with the company between 10 and 14 years and 36 of them have been with the company for 15 years or plus. So nearly 1/3 of our home office team has been with the company for 10 years-plus, and I think that's pretty impressive, considering we're a company that has just a 17-year history.
And so with that, that concludes my report. I'll throw it back over to John.
John Michael Matovina
Thank you, Ron and Ted, and just a quick summary before we take questions about the prospects for the balance of the year. As we've commented, the sales are off to a good start, and we're enthusiastic about what second quarter is going to bring.
Earnings are off to a good start as well, with the redeployment of the cash and the expansion or reinstatement of the spread, although, just to caution, second quarter is likely to have an interruption of that because of the level of calls that we've already experienced. But we're still enthused about getting that spread back up to the 3% target and -- as the year progresses.
So with that, we'll turn the call -- or open the call up to questions.
Operator
[Operator Instructions] Your first question comes from the line of Randy Binner of FBR.
Randy Binner - FBR Capital Markets & Co., Research Division
Just wanted to ask a few questions, if I could, just about spreads and kind of the elevated cash balance. And so maybe just picking up on John's last comment there about the interruption in the redeployment process.
The way I'm thinking of it in our model is that this $678 million was kind of anticipated or it was announced by you a while ago. So in my mind, it would basically keep the kind of excess cash balance at its current level, maybe call it $1.6 billion to $1.8 billion.
Is that the right way to think of it, that it kind of hovers around this level before it can get meaningfully worked down in the back half of the year?
John Michael Matovina
Well, we ended the quarter at $1.2 billion, Randy. The $1.8 billion was the average for the quarter.
So -- but I would think the balance when we end the second quarter is going to be above the $1.2 billion.
Randy Binner - FBR Capital Markets & Co., Research Division
Okay, that's helpful around the clarification. So it's something like between $1.2 billion, $1.5 billion?
John Michael Matovina
Could be even higher than that. I mean, the other thing we're seeing at the moment, I guess, is that there's been a backup in treasury rates and that's flowed a little bit, I think, in the securities we're investing in.
So I know we're not quite at the same pace of investing as we've made in the first quarter. So could be on the high end, a $1.8 billion to $2 billion number unless the pace really picks up, ending balance at the end of Q2.
Randy Binner - FBR Capital Markets & Co., Research Division
Right, okay. And then -- all right.
So kind of I got -- my conclusion was right but the wrong numbers but I'll take it. And then the money you’re putting into work, you mentioned that you are purchasing some new government.
I think you said some government RMBS at 312 basis points. What is that exactly, if I heard that correctly?
John Michael Matovina
It's not RMBS. It's agency securities of the type that have caused all the calls now but they're -- they don't get called if rates stay at these levels.
Randy Binner - FBR Capital Markets & Co., Research Division
Okay. And so that's a good segue into the third part of my question.
And that is, I missed the July call amount. Sorry, that went by too fast.
What was the amount that you said was up for the call in July?
John Michael Matovina
It's $504 million but no securities are -- we consider those short-term investments, so they're already in the $1.2 billion cash balance number.
Randy Binner - FBR Capital Markets & Co., Research Division
Okay, got it. Okay, that's helpful because I didn't recall hearing about the July cut out before.
What's the yield on those?
John Michael Matovina
The yield is 75 basis points. If they don't get called, although they're expected to be called, the yield would jump up to 3.75%.
Randy Binner - FBR Capital Markets & Co., Research Division
Okay, so they'll get called. And then looking into the other amounts you referenced for December and January, would those be similar to these new agency securities you're buying, in that if rates stay at current levels, they would be less likely to be called?
John Michael Matovina
If rates stay at current levels, they will not be called.
Randy Binner - FBR Capital Markets & Co., Research Division
Is there a level of rates as measured by the 10-year where we would think about the new agencies or those other ones in December and January getting called if rates -- if the 10-year broke out to like 2.50% or something like that?
John Michael Matovina
If the 10-year goes up, they won't be called. If the 10-year -- Jeff Lorenzen, you got any insight into what level of the 10-year might need to drop to before those things would be at risk of being called?
Jeff Lorenzen
I think you need to be well below 1.5% on the 10-year.
Randy Binner - FBR Capital Markets & Co., Research Division
Below 1.5%. I misspoke, I said up not down.
So 150 is kind of the floor here. Thanks for the math.
Randy Binner - FBR Capital Markets & Co., Research Division
. Your next question comes from the line of Steven Schwartz of Raymond James & Associates.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
Just to follow up a little bit. Ted, how much did you invest in the quarter in long-term bonds and in other long-term instruments in CML?
Ted M. Johnson
Jeff, I think, am I right, was it about $1.3 billion? Was that our run rate?
Jeff Lorenzen
Sounds about right, yes.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
Okay. And John, you're intimating that given the backup in rates, that it might be a little bit less than that this quarter.
John Michael Matovina
Yes. The number in the first quarter was $2.3 billion that we put to work.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
In long term?
John Michael Matovina
In long -- in fixed -- yes, in long-term securities, yes.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
Okay. All right.
So a very, very fast rate, actually, okay. And then just on the business-wise, Ron, you seem to intimate that your historical competitors were behaving themselves.
Do we take from that, that we haven't seen anything new out of Aviva, AmerUs theme since the takeover?
Ronald J. Grensteiner
Well, Aviva has introduced a new product that's based around income, and that's really what they're targeting there. Although according to the field, it hasn't really taken off.
It sounds like it might be a little complex. So it sounds like a product that is what I would consider -- as you said, Steven, behaved.
It's a well-behaved product, but it's a little bit complex so sales aren't really taking off on it. Athene introduced a product under the umbrella of Athene, which we thought was a little bit aggressive.
But we haven't really seen sales tick up on that either. So it will be interesting to see what the second quarter brings.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
Okay. And then just looking at some statutory things.
There's a change in how -- in formulas regarding mortgage-backed securities, John. Anything to note there?
John Michael Matovina
I'm not sure I know what you're talking about there.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
Okay. Maybe I don't know what I'm talking about.
John Michael Matovina
There already was a change like last quarter already where they would change the weighting on the various scenarios, and they gave a higher weighting to some more of their severe scenarios, but that didn't have really kind of any large effect to us.
Ronald J. Grensteiner
Steve, I think what you may be thinking about -- the mortgage-backed securities have been dealt with going back several years ago in the PIMCO process that assigned values to each security that then determined the category it fit into. And that process, I think, was extended to CMBS and maybe some asset-backed securities.
What's going on is in the commercial mortgages they're coming up with a system, and I believe I've heard that the commissioners had a telephonic call or whatever and approved this just this week, although I'm not absolutely certain of that. But it sounds like this is headed toward implementation where the concept for commercial mortgages, which we've had this mortgage experience adjustment factor, the MEAF, as it was the acronym, that's going to disappear from commercial mortgages, I don't think this year, I think next year.
And the risk-based capital for commercial mortgages is going to be based upon some objective information, loan-to-value ratios, debt service coverages. I think I've heard also that, for instance, you can have -- we have a lot of commercial mortgage loans with 10-year final terms and 25-year amortizations.
We don't have any interest-only, but other life companies do. So there's going to be some sort of conversion that puts all loans on the same basis so that you can obviously have a better -- you can have a higher debt service coverage.
If you only have the coverage, you're only having to pay interest versus principal and interest. So there's going to be a mechanism to standardize the terms of the mortgages so that it's apples-to-apples among all companies.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
Okay. But nothing yet to really get your...
Ronald J. Grensteiner
I believe that 2014 is when it gets implemented.
Operator
Your next question comes from the line of Mark Hughes of SunTrust.
Mark D. Hughes - SunTrust Robinson Humphrey, Inc., Research Division
In order to get back to the 300-basis-point spread target, how much would you have to do on the crediting side to get there? Can you just talk about the kind of the steps that you have to take in order to return to your goal?
John Michael Matovina
Mark, I don't have a fresh analysis. What I had from about 6 weeks ago was another 15 to 20 basis points, and we'll be making another updated analysis in the very near future to make sure that, that's going to get it done.
Mark D. Hughes - SunTrust Robinson Humphrey, Inc., Research Division
And when might that be implemented?
John Michael Matovina
Early third quarter, it'll start.
Mark D. Hughes - SunTrust Robinson Humphrey, Inc., Research Division
Okay. And then from a competition standpoint, those kind of in and outers or new entrants that are more aggressive, are they -- is the level of that activity, is that consistent with prior quarters?
Was it a little less this quarter and that's why you're getting uptick in sales activity? Or is the underlying demand so strong that it's overcoming even more of that competition?
John Michael Matovina
I think it may be a mixed bag, Mark. I think there is certainly demand for the products as the baby boomers start to retire and recognize the value of them.
I think we can also speculate that as Aviva is being sold, that there might be some agents who aren't sure of what the final outcome is going to be so we might be able to get some market share from them. Allianz has been pretty quiet.
As you know, we might be getting a little bit market share from them. So I think it's kind of a mixed bag.
I don't know if we can put a finger on any one thing that is doing it, Mark, but I think it's a little bit of each.
Operator
. At this time, there are no additional questions in the queue, and I would like to turn the call back over to management for closing.
Julie L. 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. Have a wonderful day.