Athene Holding Ltd. quarterly report, Q3 FY2018

Athene Holding Ltd. 2018 Q3 SEC Filing Summary

Business context and reporting period

Athene Holding Ltd. is a Bermuda-based retirement services company that issues, reinsures and acquires fixed annuities, fixed indexed annuities, payout annuities, funding agreements and pension risk-transfer obligations. The unaudited Form 10-Q covers the three and nine months ended September 30, 2018, with comparisons to the corresponding 2017 periods.

Athene reports one core segment, Retirement Services, and a Corporate and Other category. On January 1, 2018, Athora was deconsolidated; its results are no longer consolidated, reducing comparability with 2017.

Financial performance and key metrics

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Total revenues	$2.588 billion	$1.473 billion	$5.396 billion	$4.855 billion
Income before taxes	$706 million	$294 million	$1.363 billion	$1.037 billion
Net income	$640 million	$274 million	$1.172 billion	$984 million
Adjusted operating income	$381 million	$231 million	$908 million	$777 million
Adjusted operating ROE	17.5%	12.8%	14.5%	15.0%
Net investment income	$1.070 billion	$820 million	$2.883 billion	$2.427 billion
Operating cash flow	Not separately provided	Not separately provided	$1.235 billion	$1.342 billion

Q3 net income increased 134%, while nine-month net income increased 19%. Q3 adjusted operating income increased 65%; nine-month adjusted operating income increased 17%. Q3 results benefited substantially from favorable FIA derivative valuation changes and annual assumption unlocking, while nine-month results also reflected the Voya transaction and higher investment income.

Reported net income margins were approximately 24.7% in Q3 2018 and 21.7% for the first nine months of 2018, calculated as net income divided by total revenues. These margins include significant investment and derivative valuation volatility and are not equivalent to operating margins.

Q3 investment-related gains were $823 million, compared with $473 million in 2017; nine-month investment-related gains were $585 million, compared with $1.615 billion in 2017.
The consolidated net investment earned rate was 4.52% in Q3 and 4.61% for the nine months, compared with 4.45% and 4.55%, respectively, in 2017.
The deferred-annuity investment margin was 2.57% in Q3 and 2.70% for the nine months, down from 2.76% and 2.86%, respectively, in 2017. Higher cost of crediting and lower fixed-asset yields pressured the margin.
Organic deposits were approximately $8.0 billion for the nine months, while liability outflows were $5.7 billion. Fixed-annuity sales were $5.5 billion, compared with $4.1 billion in 2017.

Balance sheet, debt and liquidity

Total assets were $118.204 billion at September 30, 2018, compared with $99.747 billion at December 31, 2017.
Total investments, including related-party investments, were $101.384 billion, compared with $84.367 billion at year-end 2017. Invested assets were $100.620 billion, compared with $82.298 billion.
Total liabilities were $109.135 billion and shareholders’ equity was $9.069 billion, compared with $90.539 billion and $9.208 billion, respectively, at December 31, 2017.
Cash and cash equivalents were $3.723 billion, with total cash including restricted cash and consolidated VIE cash of approximately $3.943 billion.
Athene issued $1.0 billion of unsecured senior notes due January 2028 with a 4.125% coupon. Long-term debt was $991 million at quarter-end. A $183 million FHLB short-term borrowing was repaid during Q3.
Athene reported approximately $2.0 billion of excess capital and stated that it maintained capital ratios considered strong for its ratings. The filing does not provide updated September 30, 2018 U.S. RBC and Bermuda capital ratios in the cited discussion; the latest stated year-end 2017 U.S. RBC ratio was 490% and BSCR ratio was 354%.
Liquid assets for liquidity-monitoring purposes were $50.8 billion. Athene also had an undrawn $1.0 billion revolving credit facility and access to FHLB borrowing arrangements.

Material changes versus the prior comparable period

Voya reinsurance transaction: On June 1, 2018, Athene assumed approximately $19.035 billion of liabilities through coinsurance and modified coinsurance agreements. The transaction contributed $19.1 billion of deposits and generated a reported net cost of reinsurance of $1.174 billion, substantially offset by related deferred balances. It materially increased assets, policy liabilities, funds withheld balances and earnings volatility.
Deconsolidation of Athora: Athora became a related-party investment rather than a consolidated subsidiary on January 1, 2018. Management estimated that deconsolidation reduced total assets by $6.3 billion and invested assets by $6.0 billion.
Investment portfolio growth: Mortgage loans increased to $9.371 billion from $6.233 billion, while funds withheld at interest, including related parties, increased to $21.804 billion from $7.085 billion, primarily due to the Voya transaction.
Accumulated other comprehensive income: AOCI declined to $43 million from $1.415 billion, primarily due to higher interest rates and wider credit spreads. Gross unrealized losses on available-for-sale fixed-maturity securities increased to $1.107 billion from $246 million.
Share structure: Class A shares outstanding increased to 164.849 million from 142.387 million at year-end 2017, while Class B shares declined to 25.483 million from 47.422 million, reflecting share conversions and related activity.
Accounting adoption: Adoption of ASU 2016-01 increased beginning retained earnings by $42 million and reduced AOCI by $42 million; adoption of income-tax intra-entity transfer guidance reduced beginning retained earnings by $3 million.

Guidance, outlook, commentary and unusual items

Management expects the effective tax rate and overall tax rate to average approximately 9% to 10% over the near and medium term, but cautioned that quarterly rates may vary materially.
Management expects to continue expanding retail, flow-reinsurance and institutional distribution channels and to pursue opportunistic acquisitions and block-reinsurance transactions. It generally targets mid-teen returns for organic growth and mid-teen or higher returns for inorganic growth, subject to transaction-specific risks and pricing.
Management expects higher Treasury yields and credit spreads to improve the attractiveness of annuity products and new investment purchases over time, but noted that market volatility can raise hedging costs and reduce investment valuations.
The Tax Act and uncertainty over the BEAT led Athene to restructure affiliated modified-coinsurance arrangements and implement additional reinsurance arrangements. Q3 income tax expense included a $42 million benefit from reversing previously accrued taxes, partially offset by $2 million of excise tax expense.
Athene recorded $6 million of net other-than-temporary impairment losses for the nine months, compared with $25 million in 2017.
Athene recorded an out-of-period adjustment related to Global Atlantic balances that increased policy loans by $12 million, reinsurance recoverable by $354 million, interest-sensitive contract liabilities by $292 million and future policy benefits by $74 million. Management determined the adjustment was not material and it did not affect income, equity or cash flows.
Subsequent to quarter-end, Athene entered into a potential strategic partnership allowing investment of up to $2.5 billion over three years in Apollo-managed funds, subject to approvals and existing governance processes.
In October 2018, a court approved an immaterial monetary settlement in the Griffiths matter, including a capital maintenance agreement for certain structured-settlement obligations.

Principal risks and contingencies

Interest-rate, credit-spread, equity-market and foreign-currency movements can materially affect investment values, AOCI, derivative valuations, policyholder liabilities, hedging costs and reported earnings.
FIA embedded derivative liabilities were $8.656 billion and classified primarily as Level 3. A hypothetical 100-basis-point increase in discount rates was estimated to reduce the liability by $690 million, while a 100-basis-point decline was estimated to increase it by $792 million.
A 25-basis-point immediate parallel increase in interest rates was estimated to reduce pre-tax consolidated income by $163 million at September 30, 2018; actual outcomes may differ materially.
The investment portfolio includes significant structured securities, private placements, mortgage loans, alternative investments and related-party investments. Approximately 94.0% of AFS fixed-maturity securities were investment grade under NAIC designations, but the NRSRO-based below-investment-grade proportion was 14.8%.
BEAT interpretation, potential U.S. taxation of Bermuda entities, CFC and RPII rules, FATCA, future tax-law changes and the ability to use deferred tax assets could increase tax liabilities or reduce shareholder returns.
Athene had $3.123 billion of investment commitments, primarily to investment funds, compared with $2.358 billion at year-end 2017. The commitments may become due upon counterparty request.
The Caldera litigation includes claims against AHL seeking alleged damages of at least $1.5 billion. The filing states that reasonably possible losses cannot currently be estimated and that Athene intends to defend the matter.
Regulatory inquiries may continue regarding policy administration and conversion issues involving the Global Atlantic-reinsured block. Additional fines, penalties or policyholder payments are possible, although management does not expect them to be material.
Athene relies heavily on Athene Asset Management and Apollo-affiliated investment services. Related-party fees, conflicts of interest and limitations on Athene’s ability to terminate investment-management agreements are material governance considerations.

Important facts for investors to verify

Whether the Voya reinsurance transaction produces the expected investment margin and returns after higher crediting costs, hedging costs and reserve requirements.
The sustainability of adjusted operating income excluding favorable FIA derivative valuation changes, annual unlocking and tax benefits.
Updated statutory capital, U.S. RBC, ALRe RBC and BSCR ratios after the December 31, 2018 tax-factor changes.
The ultimate impact of BEAT guidance and Athene’s reinsurance restructuring on effective and overall tax rates.
Credit performance, realized losses and impairment trends in the structured-securities, mortgage-loan, private-placement and alternative-investment portfolios.
Potential exposure from the Caldera litigation, regulatory examinations and the COLI matter, including the $176 million stated value of COLI guarantees.
The terms, approvals and actual deployment under the post-quarter-end Apollo strategic partnership.
Changes in liquidity, surrender activity, collateral requirements and access to subsidiary dividends or external financing.