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FGL Holdings (NYSE:FG)
Q1 2020 Earnings Call
May 07, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning, and welcome to the FGL Holdings first-quarter 2020 earnings conference call and webcast. Please note, this event is being recorded and will be available for replay. I would now like to turn the conference over to Wes Carmichael, AVP, corporate development and investor relations. Please go ahead.

Wes Carmichael -- Corporate Development and Investor Relations

Thank you, operator, and good morning, everyone. We appreciate you joining our earnings call. Today, we will discuss our financial results for the first quarter of 2020, which ended on March 31. You can find the financial information for FGL Holdings on the investors section of our website, fglife.bm.

Today's presenters include Chris Blunt, president and chief executive officer; and John Fleurant, executive vice president and chief financial officer. Some of the comments we make during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. We do not intend to update any comments on this call to reflect new information, subsequent events or changes in strategy. A number of risks and uncertainties exist that could cause our actual results to differ materially from those expressed or implied.

We discuss these factors in detail in our 2019 10-K filed with the SEC on March 2, 2020. During this call, we may refer to non-GAAP financial measures that we believe may be meaningful to investors. Please refer to our first-quarter earnings release, earnings presentation and financial supplement posted to our website. These documents contain a reconciliation of non-GAAP financial measures to GAAP.

All comparison comments today will be for the first quarter of 2019, unless we state otherwise. Finally, as we noted in our earnings release issued last night, due to the pending transaction with FNF, there will not be a question-and-answer session this morning. And with that, it's my pleasure to now turn the call over to Chris.

Chris Blunt -- President and Chief Executive Officer

Thanks, Wes, and good morning, everyone. Before we get into results, I would like to take a moment to address the current environment. It's been a challenging time, and I hope all of you and your families are well. The COVID-19 pandemic has touched all aspects of our lives and has created unprecedented global challenges for the economy, as well as our personal lies.

Despite the challenges at F&G, we're operating as close to business as usual as possible while protecting the health and well-being of our employees. 96% of our workforce is now working remotely, and I'm glad to say that we're continuing to provide high-quality and consistent service to our policyholders and distribution partners. F&G is financially strong and well-positioned for the long term. Our products are working as designed.

Our policyholders are protected for market declines and can rely on the promises we've made them. The inherent guarantees of our products are built exactly for times like these. Additionally, we're committed to our growth strategy of expanding our annuity distribution and growing our life sales. With that, our focus remains on recruiting top talent to F&G in support of this expansion, and we're on track to relocate our headquarters to a larger office space in Des Moines later this year.

Turning to results. I'm pleased to announce strong sales for the first quarter of 2020, including a record quarterly level for fixed index annuity sales. Core FIA sales were up 24% year over year, and F&G's total sales were up 5%. John will provide further details around our financials, but I want to highlight that underlying results were solid in the quarter, and we were able to expand FIA net investment spread by 51 basis points year over year despite the nearly 125-basis-point decline in the 10-year treasury yield in the quarter.

While risk-free rates declined dramatically, we saw credit spreads increase across the board. Given the dislocation in the market, we took advantage of attractive new money yields and allocated a higher percentage of purchases for AA and AAA securities. While investing in highly rated assets, we were still able to price products at attractive returns. Reported yield fell modestly versus the fourth quarter of '19, driven by lower floating rate income.

However, I want to remind everyone that while reported yield is an important element of how we make money, it is only one driver of the business. We can and do regularly reprice our products to manage the net investment spread targets. It's the net investment spread, not yield alone, that drives our core earnings, and this certainly proved out in the first quarter. Excluding notable items, our adjusted operating income was in line with the first quarter of 2019 at $65 million.

Due to market movements in the quarter, our reported GAAP earnings and book value experienced a heightened level of mark-to-market volatility. Since the end of the first quarter, the equity and credit markets have rebounded and the marks on our investment portfolio have improved. Regarding the investment portfolio, Blackstone's partnership managing the general account remains a differentiated competitive advantage for F&G. John will walk you through an overview of the portfolio, including a new severe stress scenario analysis.

The bottom line is that we feel comfortable with the makeup of our investment portfolio, in particular, how it relates to our liabilities. In fact, even in a severe stress scenario that assumes materially higher defaults and mark-to-market impacts to those seen in the great financial crisis, we expect the impact to be manageable even before any management action. John will walk through the results of the stress test scenario, but I also wanted to share that we will be hosting an investor update via webcast and conference call sometime in June. We would like to provide an update on a few fronts, including our plans for accelerated growth as part of FNF following the merger close, the current market environment and our business, and a deep dive into the investment portfolio in partnership with members of Blackstone.

No date has been set yet, but stay tuned for details on logistics in the near future. Finally, I would like to make a few comments regarding the merger agreement with FNF. We are on track to close the deal, and we're targeting a close by the end of the second quarter of 2020 and no later than the beginning of the third quarter. I also want to reiterate that we are excited to join the FNF family of companies and believe that under FNF's ownership, we will be able to expand growth in our core channel, jump-start our launch into new channels and accelerate our path toward higher ratings.

With that, I'll turn it over to John to provide more details on the financial performance during the quarter.

John Fleurant -- Executive Vice President and Chief Financial Officer

Thanks, Chris, and good morning, everyone. Today, I'll focus my comments on the following: capital and liquidity, earnings and performance trends across the business, and I'll wrap up with some highlights from our recent portfolio stress test. First, as a backdrop, we ended 2019 in a very strong financial position. Today, despite the current macroeconomic situation, we remain confident with our liquidity and capital position.

Regarding liquidity, we ended the quarter with over $350 million of available cash at our operating companies. This is three times our normal level of cash buffer. In addition, we have meaningful positive net new business flows, and we have over $12 billion of high-quality liquid assets. Our $250 million revolving credit facility remains undrawn, and our $550 million senior notes do not mature until 2025 with no other debt on our books.

As it relates to capital, we finished the first quarter with an estimated risk-based capital or RBC ratio of about 425% on a consolidated basis, compared to 450% in the first quarter of 2019 and 470% at year-end. The RBC decline in the current quarter was driven by the effects of mark-to-market items. I will speak further to these items as we walk through earnings and the performance trends across the business. We reported adjusted operating income available to common shareholders of $33 million or $0.15 per share.

Our underlying earnings available to common shareholders were $65 million after adjusting for $32 million, $0.15 per share of unfavorable notable items that are not consistent period to period. These notable items included $0.10 per share for charges to reestablish a tax valuation allowance for one of our offshore subsidiaries that had been released in the third quarter of 2019; $0.02 per share in unfavorable SPIA mortality experience and other reserve adjustments; $0.02 per share of out-of-period, nondeferred commission expense true-up; and $0.01 per share of higher project-related expenses. For comparison, last year's first-quarter AOI of $82 million or $0.37 per share included favorable notable items of $17 million or $0.08 per share. Adjusting for these notable items in both periods, the first-quarter result was in line with the prior year at $65 million.

We continue to drive core earnings through ongoing invested asset growth and a disciplined crediting rate strategy. Turning to reported net income on a GAAP basis. During the quarter, we reported a net loss available to common shareholders of $346 million or $1.62 per share. This result was primarily driven by $379 million of unfavorable mark-to-market movement due to the inherent asymmetry in accounting for assets and liabilities under GAAP reporting, all of which are excluded from adjusted operating income.

These items are detailed in our earnings release published last night. We ended the quarter at a book value per share, excluding AOCI, of $6.82. Stripping out investment and liability-related mark-to-market movements of $1.59 per share, our book value per share was $8.41. The remaining $0.15 per share decrease from book value per share of $8.56 at year-end was primarily driven by the adoption of the new current expected credit loss or CECL accounting standard.

There is a page in our presentation detailing this analysis of book value per share. Turning to the investment portfolio, for which we have provided additional information in the presentation. Average assets under management for the quarter totaled $28.9 billion, reflecting an increase of $3 billion or 12% over the prior year, driven by net new business flows. The net average investment yield on new money was 4.47% in the quarter, including a 5% allocation to alternative assets.

Our alternative assets represent approximately $1.1 billion or 4% of the portfolio currently funded, and 55% of alternative asset commitments are still undrawn. On average, we assume a 12% return for this asset class over the life of the investment. And in the first quarter, the annualized return on alts was about 9%. As a reminder, income on our alternative assets are reported on a one-quarter lag.

The effect of the market movement on alternative asset returns in the first quarter will be reflected in second-quarter results. Next, turning to net investment income and portfolio yield. Net investment income was $317 million in the first quarter, up $28 million or 10% from the prior quarter. Net investment income grew approximately $34 million from invested asset growth and $16 million from net portfolio reposition uplift.

This was partially offset by $16 million lower floating rate income and $6 million higher planned investment expense. Compared to the fourth quarter of 2019, net investment income was $7 million lower this quarter, primarily driven by lower floating rate income. And the reported GAAP earned yield was 4.38%, down 19 basis points from last quarter. As Chris noted, while the portfolio yield is an important element of our business, what is most important is that we actively manage our net investment spread, which ultimately drives earnings and an attractive return on capital.

Net investment spread for our primary product line, FIA, was 305 basis points, up 51 basis points over the prior year. And net investment spread across all products was 224 basis points, up 7 basis points over the prior year. Page 7 in the earnings presentation lays out our track record of consistently managing FIA spread despite volatility in interest rates. Finally, I would like to turn our recent -- turn to our recent portfolio stress test.

As a baseline, our $28 billion portfolio remains high quality, and 95% of our fixed income securities are rated investment grade, including corporate and structured securities. Overall, the F&G portfolio is well diversified and tightly matched between assets and liabilities. In recent years, we recognized that we were late in the credit cycle and took appropriate actions. In 2018, we partnered with Blackstone to reposition a portion of the portfolio out of corporate bonds into a mix of investment-grade structured assets while maintaining an average NAIC 1.5 rating.

In 2019, we further derisked by selling $1 billion of lower-quality, BBB-rated corporates and reallocated the higher-quality securities. Given the COVID-19 health crisis and the current market environment, the risk teams at F&G and Blackstone have collaborated to analyze the performance of the portfolio in a variety of economic scenarios, including a severe stress scenario. In this scenario, we modeled a recessionary environment based on the extreme conditions of the 2008-2009 global financial crisis and have applied cumulative default rates and an instantaneous shock, which effectively doubled the observed annual default rates relative to the global financial crisis. The assumptions are outlined in the presentation.

We believe the assumptions in our stress testing scenario reflect the material deterioration in the macroeconomic environment relative to our expectations over the near and long term. That said, in the severe scenario, we view the impact of book value and earnings as manageable and believe the company will remain well capitalized. In this scenario, we estimated total defaults of approximately $140 million after tax, mostly driven by defaults in the corporate bond portfolio. This is equivalent to roughly 50 basis points on the total portfolio.

In addition, we estimate a $300 million after-tax unrealized loss from mark-to-market movements on our alternatives and preferred stock holdings. Unlike true impairments, we would expect the mark-to-market impact for alternatives and preferred stocks to recover over time as the markets rebound. The total of these sum to $440 million after-tax loss in a severe stress with over two-thirds of this coming from assets that are mark-to-market as opposed to being permanently impaired. This is equivalent to roughly 160 basis points of the portfolio.

$440 million of after-tax impact on the portfolio is about 1.4 times our full-year 2019 adjusted operating income of $320 million. This compares to the moderate stress scenario we presented in the first quarter of 2019, which reflected an impact of approximately one times after tax earnings. We view these results as manageable within our capital and liquidity framework, particularly given the strong characteristics of the liabilities that we write. And with that, I'll turn it back over to Chris for his closing remarks.

Chris Blunt -- President and Chief Executive Officer

Thanks, John. In summary, we continue to have momentum in executing on our strategy, and we're pleased with the underlying performance of the business in the first quarter despite the headwinds. I would like to thank everyone for their time this morning. Stay tuned for news regarding our upcoming investor update conference call and webcast in June.

We appreciate your interest in F&G, and thank you for joining today's call. Operator, you can now end the call.

Questions & Answers:


Operator

[Operator signoff]

Duration: 20 minutes

Call participants:

Wes Carmichael -- Corporate Development and Investor Relations

Chris Blunt -- President and Chief Executive Officer

John Fleurant -- Executive Vice President and Chief Financial Officer

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