Equitable Holdings (AXA Equitable Holdings, Inc.) — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial statement amounts are generally in millions. The company operates retirement, asset management and research, life insurance, and employee benefits businesses. AXA owned approximately 72% of the company at quarter-end.
Key financial results and position
- Q3 revenue: $1.083 billion, down from $2.806 billion in Q3 2017, chiefly reflecting net derivative losses of $2.006 billion versus losses of $316 million a year earlier. Fee-related sources were stronger: investment management and service fees were $1.088 billion, up from $1.018 billion.
- Q3 earnings: Net loss attributable to Holdings was $496 million, compared with net income of $10 million in Q3 2017; diluted loss per share was $0.89. Non-GAAP operating earnings were $693 million ($1.23 diluted per share), up from $400 million ($0.71 per share).
- First nine months: Revenue was $6.923 billion versus $9.538 billion; net loss attributable to Holdings was $118 million versus net income of $351 million. Non-GAAP operating earnings increased to $1.662 billion from $1.114 billion.
- Operating segments: Q3 operating earnings were Individual Retirement $434 million, Group Retirement $134 million, Investment Management and Research $96 million, Protection Solutions $137 million, and Corporate and Other loss of $108 million. Non-GAAP operating earnings is a management measure, not GAAP net income.
- Cash flow and liquidity: Nine-month operating cash flow was negative $33 million, versus positive $1.044 billion in 2017. Investing cash outflow was $1.056 billion and financing cash inflow was $1.061 billion. Cash and cash equivalents were $4.777 billion at September 30, 2018, compared with $4.814 billion at year-end 2017.
- Balance sheet and debt: Total assets were $234.451 billion and total equity $13.871 billion. Holdings-attributable equity was $12.411 billion, down from $13.421 billion at year-end. Short- and long-term debt totaled $4.806 billion, up from $2.408 billion; the increase largely followed issuance of $3.8 billion of senior notes and a $300 million term loan. Policyholder and separate-account balances are significant liabilities; separate-account assets and liabilities were each $125.989 billion.
- Margins: The filing does not present a conventional consolidated profit-margin measure; reported results are materially affected by insurance accounting and market-sensitive derivatives.
Material changes and unusual items
- The Q3 loss was heavily affected by variable-annuity derivative accounting and market movements. Management said higher interest rates and equity markets, along with actuarial assumption updates, contributed to the derivative losses. The hedge program does not qualify for hedge accounting, so gains and losses can be recognized at different times from related reserve changes.
- The annual Q3 assumption review reduced pretax income by $160 million and net income by approximately $131 million. The updates included a $1.095 billion increase in net derivative losses and a $673 million reduction in policyholder benefits, partly offset by lower DAC amortization. Management reported a favorable $169 million effect on non-GAAP operating earnings before tax-related effects.
- Holdings increased its economic interest in AllianceBernstein from approximately 47% at year-end 2017 to approximately 65% after purchasing additional units in April 2018. Higher ownership contributed to growth in reported asset-management earnings. AB’s AUM was $550.4 billion at quarter-end; nine-month net long-term outflows were $8.8 billion.
- In April 2018, the company issued senior notes due 2023, 2028, and 2048, with coupon rates of 3.90%, 4.35%, and 5.00%, respectively, and borrowed $300 million under a delayed-draw term loan. It also repaid substantial affiliate borrowings and ended AXA-related guarantees as described in the filing.
- The company recorded a $100 million pretax pension settlement loss in Q1 after transferring approximately $254 million of pension obligations to an insurer. Nine-month pension expense was $142 million, compared with $50 million in 2017.
- Available-for-sale fixed maturities had $1.451 billion in gross unrealized losses at quarter-end, versus $324 million at year-end 2017; management said it did not intend, and was not likely required, to sell the securities before recovery.
- Comparative financial information was restated or revised for errors involving insurance benefit reserves, derivative results, and DAC amortization. The 2017 nine-month figures shown are restated. Management also revised previously reported 2018 interim and 2017 periods.
Outlook, risks and contingencies
- No formal earnings guidance is provided in the supplied filing text. The company estimated total one-time standalone/separation costs of $300–$350 million; approximately $160 million was incurred in the first nine months of 2018, and approximately $200 million was expected for full-year 2018. It projected productivity initiatives could add approximately $75 million of pretax operating earnings annually by 2020.
- Management highlighted equity-market and interest-rate sensitivity, variable-annuity guarantees, hedging effectiveness and collateral needs, policyholder behavior, reserve assumptions, investment credit risk, and the ability of insurance subsidiaries to distribute dividends. It warned that market volatility can affect fees, claims, capital, hedge costs, and liquidity.
- The NAIC adopted a revised variable-annuity capital framework expected to take effect in January 2020; implementation could materially change reserve and risk-based capital requirements. Management expects the long-duration insurance accounting standard (ASU 2018-12) to have a significant impact on financial condition, results, cash flows, disclosures, processes, and controls when adopted.
- Two material weaknesses in internal control over financial reporting remained unremediated. They concerned actuarial models, assumptions and data, and insufficient financial-reporting resources and journal-entry controls. Management concluded disclosure controls were not effective at September 30, 2018; it had added finance staff and enhanced controls but could not estimate when remediation would be complete.
- For litigation and regulatory matters, management estimated aggregate reasonably possible losses of up to approximately $90 million beyond amounts accrued, while noting it could not estimate losses for certain matters. It believed pending matters were not likely to materially affect financial position, but adverse outcomes could affect quarterly or annual results and cash flows.
- After quarter-end, the company disclosed a November 2018 incident at a third-party vendor involving unauthorized access to confidential information of certain customers. Investigation and notifications were underway; the company said it could not yet assure all causes had been identified or remediated.
- Subsequent to quarter-end, Holdings declared a $0.13 per-share dividend and increased its repurchase authorization by $300 million to $800 million, expiring March 31, 2019. The authorization does not require the company to repurchase shares. By September 30 it had repurchased approximately 2.5 million shares for $57 million.
Important facts for investors to verify
- Review the restatement disclosures and the remediation progress for the two material weaknesses, particularly actuarial reserve/DAC modeling and financial close controls.
- Assess the drivers and potential persistence of derivative-related GAAP volatility, including the actuarial assumptions and hedge/reinsurance offsets underlying variable-annuity guarantees.
- Evaluate debt-service capacity, subsidiary dividend restrictions, collateral requirements, and the effect of market stress on insurer statutory capital and liquidity.
- Track investment performance and flows: AB’s nine-month net outflows, the concentration and unrealized losses in the fixed-income portfolio, and the company’s exposure to higher rates and equity volatility.
- Monitor the vendor security incident, litigation and regulatory developments, and the actual costs and realized savings from the standalone transition and productivity program.