Athene Holding Ltd. quarterly report, Q2 FY2017

Athene Holding Ltd. — 2017 Q2 Form 10-Q Summary

Business context and reporting period

Athene is a Bermuda-based retirement services company that issues, reinsures and acquires fixed annuities and other retirement savings products in the United States, Bermuda and Germany. The filing covers the unaudited quarter and six months ended June 30, 2017, with comparisons to the revised comparable periods in 2016. The principal reportable segment is Retirement Services.

Key financial metrics

Metric	Three months ended June 30	Six months ended June 30
Total revenue	$1.763 billion vs. $1.045 billion	$3.382 billion vs. $1.767 billion
Net income attributable to shareholders	$326 million vs. $193 million	$710 million vs. $278 million
Operating income, net of tax	$280 million vs. $179 million	$546 million vs. $331 million
Income before taxes	$337 million vs. $208 million	$743 million vs. $293 million
Effective tax rate	3% vs. 7%	4% vs. 5%
Diluted Class A EPS	$1.65 vs. $1.04	$3.59 vs. $1.49
ROE	16.4% vs. 12.8%	18.7% vs. 9.4%
Operating ROE excluding AOCI	15.9% vs. 12.4%	15.9% vs. 11.6%

Amounts are in U.S. dollars; balance-sheet amounts are as of June 30, 2017 unless otherwise stated.

Net investment income was $821 million in the quarter and $1.607 billion year to date, compared with $700 million and $1.394 billion, respectively, in 2016.
Investment-related gains were $460 million in the quarter and $1.142 billion year to date, compared with $227 million and $143 million, respectively. The increase was primarily related to FIA hedging derivatives, reinsurance embedded derivatives and other derivative results.
Premiums were $379 million in the quarter and $431 million year to date, including approximately $320 million from Athene’s inaugural pension risk transfer transaction.
Total assets were $93.594 billion, up from $86.699 billion at December 31, 2016. Total investments, including related parties, were $78.699 billion, and invested assets were $76.279 billion.
Shareholders’ equity was $8.284 billion, including $1.060 billion of accumulated other comprehensive income. Retained earnings were $3.772 billion.
Reserve liabilities were $75.290 billion, compared with $70.974 billion at year-end 2016.
Net cash provided by operating activities was $1.073 billion, compared with $704 million in the prior-year period. Investing activities used $2.640 billion, while financing activities provided $2.569 billion. Cash and cash equivalents increased by $1.021 billion to approximately $3.480 billion.
AHL had no financial leverage at June 30, 2017. The company had an undrawn $1.0 billion revolving credit facility and access to Federal Home Loan Bank funding arrangements. Funding agreements outstanding included $679 million issued to the FHLB and $1.696 billion under the funding agreement-backed notes program.
The company reported more than $1.5 billion of excess capital and stated that it maintained capital ratios above internal targets. The latest disclosed U.S. RBC and Bermuda BSCR ratios were 478% and 228%, respectively, as of December 31, 2016; June 30, 2017 ratios were not stated in the filing.

Margins, sales and operating performance

For deferred annuities, the six-month net investment earned rate was 4.80%, cost of crediting was 1.90%, and investment margin was 2.90%, compared with 4.58%, 1.97% and 2.61%, respectively, in 2016.
Quarterly investment margin increased to 2.96% from 2.59%, reflecting a higher earned rate and lower cost of crediting.
Organic-channel deposits were $5.1 billion year to date, compared with $4.0 billion in 2016. Fixed annuity sales were $2.7 billion, compared with $1.8 billion.
Flow reinsurance deposits declined to $380 million from $2.2 billion, while funding agreements issued during the first half totaled approximately $1.7 billion.
Retirement Services operating income increased to $267 million for the quarter and $542 million year to date, from $196 million and $393 million, respectively.

Material changes versus the prior comparable period

Quarterly net income increased 69% and six-month net income increased 155%, driven by higher operating income and favorable market-related changes in FIA derivatives and reinsurance embedded derivatives.
Revenue growth reflected increased deposits and investment assets, stronger net investment income, favorable derivative results and the pension risk transfer transaction.
Benefits and expenses increased substantially, including higher interest-sensitive contract benefits, future policy benefits, DAC/DSI/VOBA amortization and policyholder dividends. These increases largely reflected business growth and market-related changes in indexed annuity liabilities.
Investment assets grew through deposits, reinvested earnings and unrealized gains. Unrealized gains on available-for-sale securities increased as credit spreads tightened and U.S. Treasury rates declined.
The investment portfolio remained concentrated in fixed maturity securities, which represented approximately 72% of total investments excluding related parties. Approximately 93.4% of fixed maturity securities were investment grade under NAIC designations 1 or 2, while 17.7% were below investment grade under NRSRO ratings.
Net other-than-temporary impairment losses declined to $12 million from $21 million in the first half of 2016.

Guidance, outlook, commentary and unusual items

Management did not provide explicit full-year earnings guidance. It expects organic growth through retail, flow reinsurance and institutional channels, with additional acquisition and block-reinsurance opportunities in stressed markets.
Management cited an expected annual investment margin of 2%–3% over the 8.1-year weighted-average life of deferred annuities and indicated that approximately 29% of invested assets were floating-rate investments, providing sensitivity to higher short-term rates.
The Department of Labor fiduciary rule remained a significant business and regulatory uncertainty. Management stated that implementation could increase compliance costs, affect distribution practices and reduce annuity sales, particularly for IRA and employee-benefit-plan products.
The company recorded out-of-period adjustments primarily involving DAC and VOBA amortization and actuarial reserves. Management stated that reported net income was overstated by $16 million for the quarter and $15 million for the six months, but concluded the adjustments were not material.
The 2016 comparative financial statements were revised for immaterial errors involving investment income, contract benefits, DAC amortization, taxes and cash-flow classifications.
During the second quarter, Athene amended its fee arrangements with Apollo-related investment managers. The annual fee on certain North American assets above $65.846 billion was reduced from 0.40% to 0.30%, subject to specified conditions and thresholds.
After quarter-end, Athene agreed to acquire Aegon Ireland plc, subject to regulatory and customary closing conditions, with closing expected in the first quarter of 2018. AGER is expected to be deconsolidated following a capital call, and Athene may record a gain or loss based on changes in the value of the AGER Group.

Risks, contingencies and unusual exposures

Interest-rate, credit-spread, equity-market, foreign-currency, liquidity and counterparty movements can materially affect investment values, derivative results, reserves, capital and earnings.
The company held $10.539 billion of available-for-sale securities in an unrealized-loss position, primarily due to interest-rate changes. Management stated that it intended and was able to hold the securities until recovery or maturity.
Commitments to make investments, primarily capital contributions to investment funds, totaled $1.450 billion and could become due upon counterparty request.
A pending structured-settlement annuity class action remains unresolved; management believes it has meritorious defenses and stated that reasonably possible losses cannot currently be estimated.
IRS disputes concerning the tax treatment of FIA hedges and marketing commissions could result in tax liabilities. Athene expects approximately $120 million of tax, plus interest, if one historical issue is upheld, although relevant amounts are subject to potential indemnification by Aviva plc under the purchase agreement.
The company reported increased service and administration complaints associated with certain policies administered by a third-party administrator. New York and Texas regulators indicated intended examinations or enforcement proceedings.
A new risk factor concerns potential withholding of cash flows from legacy RMBS trusts to fund trustee litigation expenses, which could adversely affect the value, ratings and yield of Athene’s RMBS portfolio.
Related-party and investment-management dependence on Apollo and AAM is material. AAM directly managed $56.952 billion of portfolio assets, and Apollo-affiliated entities sub-advised approximately $13.495 billion.

Investor verification checklist

Verify the sustainability of earnings excluding the substantial derivative, market-related and other non-operating gains.
Reconcile the reported $16 million quarterly and $15 million year-to-date out-of-period adjustments and assess whether future reserve or DAC revisions may occur.
Review statutory capital, RBC and BSCR ratios as of June 30, 2017, since the filing provides the latest detailed ratios primarily as of December 31, 2016.
Assess exposure to FIA guarantees, policyholder behavior, surrender rates, crediting-rate resets and prolonged low interest rates.
Review the credit quality and valuation methodology of RMBS, CLOs, structured assets, mortgage loans and Level 3 investments.
Monitor the DOL fiduciary rule, related distribution changes and potential effects on FIA and traditional fixed-annuity sales.
Evaluate the pending Aegon Ireland acquisition, proposed AGER deconsolidation, funding requirements and potential accounting gain or loss.
Review tax disputes, third-party administrator issues, litigation matters and potential indemnification recoveries from Aviva plc.