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American Equity Investment Life HoldingĀ (NYSE: AEL)
Q1Ā 2019 Earnings Call
May. 02, 2019, 9:00 a.m. ET
Welcome to the American Equity Investment Life Holding Company’s first-quarter 2019 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.
Julie LaFollette — Coordinator of Investor Relations
Good morning, and welcome to American Equity Investment Life Holding Company’s conference call to discuss first-quarter 2019 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. Presenting on today’s call are John Matovina, chief executive officer; Ted Johnson, chief financial officer; and Ron Grensteiner, president of American Equity Investment Life Insurance 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 those actual results to differ materially are discussed in detail in our most recent filings with the SEC. An audio replay will be made available on our website shortly after today’s call.
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It is now my pleasure to introduce John Matovina.
John Matovina — Chief Executive Officer
Thank you, Julie. Good morning, everyone, and thank you for joining us this morning. Our first-quarter results were again solid, giving us a strong start to the year. Non-GAAP operating income for the quarter was $89 million, $0.97 a share.
That’s almost flat with the fourth quarter of 2018 despite a decline in the benefit from the non-trendable investment spread items we had in the fourth quarter. So as a reminder, the three key metrics that drive our financial performance are growing our invested assets and policyholder funds under management, generating a high level of operating earnings and growing asset base through investment spread, and then minimizing impairment losses in our investment portfolio. So for each of those measures in the first quarter, policyholder funds under management, we delivered 1% sequential growth. In a trailing 12-months basis, it was 5%.
On a trailing 12-month basis, we generated about a 16% non-GAAP operating return on average equity. That excludes the impact of the actuarial assumption reviews that we had in the third quarter of last year. And in the first quarter, we do not have any investment impairment losses, but we did incur some modest capital losses on the sales of a few fixed maturity securities. The growth in policyholder funds under management for the quarter was driven by $1.2 billion of gross and net sales that reflects the new products that were introduced and crediting rate changes that we made in the fourth quarter of last year.
Sales have been on the upswing the last three quarters, and that momentum has carried over into the second quarter. You’ll hear more about the sales environment and competition from Ron in a few minutes. We delivered a sequential increase in investment spread in the first quarter despite a lower benefit from the non-trendable spread items. The sequential decrease was largely due to a lower cost of money, which benefited from decreases in the cost of options purchased in the fourth quarter and early in the first quarter.
The cost of option purchases has risen since early January as volatility has declined, but the overall cost still remains below the weighted average cost that we had for 2018. Ted will have more details on investment spread in his remarks. So I’ll be back at the end of the call for some closing remarks. Now I’d like to turn the call over to Ted for additional comments on first-quarter financial results.
Ted Johnson — Chief Financial Officer
Thank you, John. As we reported yesterday afternoon, we have non-GAAP operating income of $89 million or $0.97 per share for the first quarter of 2019, compared to non-GAAP operating income of $77.7 million or $0.85 per share for the first quarter of 2018. The 2019 amounts are up 15% and 14%, respectively. Investment spread for the first quarter was 258 basis points, up 2 basis points from the fourth quarter as a result of a 5-basis-point decline in the cost of money, offset by a 3-basis-point decrease in the average yield on invested assets.
Trendable spread in the first quarter was 252 basis points, compared to 248 basis points in the fourth quarter of last year. Average yield on invested assets was 4.48% in the first quarter, compared to 4.51% in the fourth quarter of 2018. The decrease in the average yield in the quarter reflected a decline in the benefit from non-trendable investment income items, which were 7 basis points in the fourth quarter of 2018 and just 2 basis points in the first quarter of 2019. The decline from trendable investment income items was partially offset by a 2-basis-point increase in our average yield on invested assets from the $4.7 billion of floating rate instruments in our investment portfolio.
The average yield on fixed income securities purchased and commercial mortgage loans funded in the first quarter was 4.69%, compared to 5.02% in the fourth quarter of 2018. The lower yield for the first quarter reflects both the general decline in interest rates, as well as a higher allocation to purchases of corporate bonds than we expect for the full year as new issuance in the structured securities market was light in the first quarter. We did not undertake portfolio realignment trades in the quarter but continue to look for opportunities to enhance our investment returns without a material increase in credit risk. As we stated in the past, we do not believe that our recent emphasis on purchases of asset-backed securities such as collateralized loan obligations has led to any material increase in credit risk.
NAIC three investments were 2.7% of fixed maturities at March 31, compared to 2.5% at year-end 2017, prior to increasing our allocations to asset-backed securities. Further, we do not believe even in a stressed — a severe stressed scenario, like the 2008 financial crisis, that our CLO or CMBS portfolios would suffer significant default losses. As we stated on our fourth-quarter 2018 earnings call, the subordination levels for CLOs required by the rating agencies at each ratings level are significantly higher than — higher today than in 2007. Applying loss or ratings migration rates incurred during the 2008 financial crisis to today’s market does not seem useful.
The aggregate cost of money for annuity liabilities was 190 basis points, down 5 basis points from the fourth quarter of 2018. The benefit of overhedging of index-linked interest obligations was 2 basis points in the first quarter, compared to 3 basis points in the fourth quarter of 2018. We estimate that trendable cost of money declined by 2 basis points in the first quarter primarily due to the sharp decline of option cost in December and continued low cost in the first quarter. As we have pointed out in the past, the cost of options for monthly point-to-point index strategies reacts inversely to volatility and the high percentage of policyholder funds, and monthly point-to-point strategies can translate into trends and option costs that are not intuitive relative to the direction of equity market volatility.
With the decline in equity market volatility since early January, we have experienced an increase in the cost of options purchased. However, the cost of options still remains below the weighted average for 2018. In part, we believe this is due to the reductions in fixed rates, caps and participation rates on annual point-to-point and monthly average strategies on $35 billion of policyholder funds under management we initiated in October. We expect this reduction to produce annual savings in the cost of money of ne