Athene Holding Ltd. quarterly report, Q3 FY2017

Athene Holding Ltd. — Q3 2017 Form 10-Q Summary

Business context and reporting period

Athene is a Bermuda-based retirement services company that issues, reinsures and acquires retirement savings products in the United States and Germany. Its principal activities include fixed indexed annuities, fixed-rate annuities, funding agreements, pension risk transfer and related reinsurance. The filing covers the unaudited quarter and nine months ended September 30, 2017, compared primarily with the same periods in 2016 and December 31, 2016 for balance-sheet items.

Key financial metrics

Metric	Q3 2017	Q3 2016	9M 2017	9M 2016
Total revenue	$1.473 billion	$1.272 billion	$4.855 billion	$3.039 billion
Income before taxes	$294 million	$38 million	$1.037 billion	$331 million
Net income attributable to AHL shareholders	$274 million	$126 million	$984 million	$404 million
Diluted EPS, Class A	$1.39	$0.68	$5.00	$2.17
Operating income, net of tax	$231 million	$117 million	$777 million	$448 million
Operating ROE excluding AOCI	12.5%	7.9%	14.8%	10.2%
Net cash provided by operating activities	Not separately provided for the quarter	Not separately provided for the quarter	$1.342 billion	$964 million

Q3 net income increased 117% year over year, while nine-month net income increased 144%. Nine-month revenue growth was driven substantially by investment-related gains, including FIA hedging derivative gains, higher premiums and higher net investment income.

Balance sheet, liquidity and capital

Total assets were $96.061 billion at September 30, 2017, up from $86.699 billion at December 31, 2016.
Total investments, including related-party investments, were $81.183 billion, compared with $72.433 billion at year-end 2016. Invested assets were $78.804 billion, compared with $71.834 billion.
Cash and cash equivalents were $3.607 billion, with restricted cash of $100 million. Cash and cash equivalents including consolidated VIE cash were $3.608 billion at period-end.
Total liabilities were $87.392 billion and shareholders’ equity was $8.669 billion, including $1.162 billion of accumulated other comprehensive income.
The company reported no financial leverage at the AHL holding-company level. It had an undrawn $1.0 billion revolving credit facility with approximately three years remaining.
Funding agreements outstanding with the Federal Home Loan Banks were $623 million. Funding agreements issued under the FABN program had a carrying value of $2.996 billion.
Management reported more than $1.5 billion of excess capital and stated that capital ratios were high relative to its rating objectives. The most recent disclosed U.S. RBC ratio was 478% and ALRe BSCR ratio was 228% at December 31, 2016; the filing states that capital remained above regulatory standards at September 30, 2017, but does not provide updated Q3 ratios.

Margins, investment portfolio and operating trends

For the nine months, the consolidated net investment earned rate was 4.55%, compared with 4.21% in 2016. The deferred-annuity investment margin was 2.86%, compared with 2.67%.
For Q3, the deferred-annuity investment margin was 2.76%, slightly below 2.79% in the prior-year quarter, as the net investment earned rate declined 11 basis points while cost of crediting declined 8 basis points.
Approximately 93.3% of AFS fixed-maturity securities, including related parties, were investment grade under NAIC designations 1 or 2. The portfolio included $58.9 billion of fixed-maturity securities at fair value.
Gross unrealized losses on AFS fixed-maturity securities declined to $273 million from $636 million at year-end 2016. Net OTTI losses were $25 million for the nine months, compared with $27 million in 2016.
Approximately 28% of invested assets were floating-rate investments, increasing sensitivity to interest rates and supporting investment income in a rising-rate environment.

Cash flow and business production

Operating activities generated $1.342 billion of cash in the first nine months, while investing activities used $4.502 billion, primarily for investment purchases. Financing activities provided $4.279 billion.
Deposits through organic channels were $8.0 billion, compared with $6.9 billion in the prior-year period. Liability outflows were $4.4 billion, compared with $4.0 billion.
Fixed-annuity sales were $4.1 billion, compared with $3.8 billion. Flow-reinsurance deposits declined to $570 million from $3.1 billion, while institutional deposits increased to $3.3 billion from none in the prior-year period.
The company completed its inaugural pension risk-transfer transaction, involving approximately $320 million of premiums, and subsequently entered into two additional PRT agreements totaling approximately $1.0 billion of pension obligations after quarter-end.

Material changes versus the prior comparable period

Retirement Services operating income increased to $244 million in Q3 and $786 million for nine months, from $142 million and $535 million, respectively.
Net investment income increased to $820 million in Q3 and $2.427 billion for nine months, reflecting portfolio growth and higher short-term rates, particularly on floating-rate investments.
Investment-related gains increased to $473 million in Q3 and $1.615 billion for nine months, compared with $380 million and $523 million, respectively. The primary driver was the fair value change in FIA hedging derivatives, aided by equity-market performance.
Benefits and expenses decreased in Q3 but increased for the nine-month period. Nine-month interest-sensitive contract benefits rose to $1.866 billion, primarily due to FIA embedded-derivative changes and higher interest credited on a larger deposit base.
The 2016 comparison was revised for immaterial errors, reducing reported nine-month 2016 net income from $437 million to $404 million. The revisions also affected revenue, expenses, EPS and cash-flow presentation.
The company recorded out-of-period adjustments that increased pretax income by $13 million for Q3 and $28 million for nine months. Management concluded the adjustments were not material to the current or prior periods.
Common-share composition changed materially: 42.3 million Class B shares converted to Class A shares during the first nine months, primarily in connection with two public follow-on offerings by existing holders.

Guidance, outlook, commentary and risks

No formal earnings guidance was provided. Management generally targets mid-teen returns for organic growth and mid-teen or higher returns for inorganic opportunities, subject to transaction-specific risks and market conditions.
Management expects continued organic growth through retail, reinsurance and institutional channels, while noting that flow-reinsurance volumes were pressured by tighter spreads, lower MYGA volumes, stock-market strength and expectations for higher interest rates.
Management expects rising interest rates could improve product attractiveness and investment income, but prolonged low rates could compress investment margins because of policyholder minimum guarantees and competitive constraints on crediting-rate reductions.
The company expects AGER to call capital in connection with the planned acquisition of Aegon Ireland plc. The transaction was expected to close in the first quarter of 2018, subject to approvals and customary conditions, and could result in deconsolidation of the AGER Group and a gain or loss based on valuation changes.
Key risks include credit, interest-rate, equity-market, foreign-currency and counterparty exposure; volatility in FIA derivative and embedded-derivative valuations; investment-fund and structured-securities risk; regulatory capital requirements; and reliance on Apollo-affiliated investment managers.
New or emphasized risks included potential adverse effects from LIBOR transition, legacy RMBS trustee litigation reserves, the DOL fiduciary rule, third-party administrator service issues involving certain reinsured blocks, OTC-derivatives margin requirements and proposed U.S. tax reform.
The IRS was auditing certain Athene and Aviva USA tax years. A potential tax exposure of approximately $120 million plus interest related to older years was described as subject to Aviva indemnification if contractual requirements are satisfied.
The filing states that no legal proceeding was believed to be material to the company’s business, financial condition, results of operations or cash flows. A separate structured-settlement matter had a proposed class settlement subject to court approval.

Most important facts for investors to verify

Reconcile GAAP net income with operating income and determine how much of the earnings increase came from recurring investment margin versus market-sensitive FIA derivative gains and other non-operating items.
Review updated statutory RBC, BSCR and other capital ratios, since the filing provides detailed current-period capital commentary but primarily quantitative ratios as of December 31, 2016.
Assess credit quality and loss sensitivity of the investment portfolio, particularly non-agency RMBS, structured securities, mortgage loans, alternative investments and related-party assets.
Monitor liquidity, collateral requirements, funding-agreement maturities, policyholder withdrawals and the availability of the revolving credit facility under stressed market conditions.
Evaluate the impact of the AGER/Aegon Ireland transaction, including capital calls, possible deconsolidation and any resulting gain or loss.
Track the implementation and financial effects of the DOL fiduciary rule, LIBOR replacement, tax reform and regulatory actions related to third-party administrators.
Review the out-of-period adjustments and revised 2016 financial statements when comparing reported trends across periods.