American National Group Inc. quarterly report, Q2 FY2013

American Equity Investment Life Holding Company — Q2 2013 Form 10-Q Summary

Filing identity: The supplied filing is for American Equity Investment Life Holding Company, not American National Group Inc. It covers the quarter and six months ended June 30, 2013. Financial statements are unaudited and amounts are in thousands unless otherwise stated.

Business Context and Reporting Period

The company primarily sells individual deferred annuities, especially fixed index annuities, and also sells life insurance. Annuity deposits are generally recorded as deposit liabilities rather than revenue; earnings are driven principally by investment income, investment spreads, policy charges, and changes in derivative values.

Key Financial Metrics

Metric	Three months ended June 30, 2013	Three months ended June 30, 2012	Six months ended June 30, 2013	Six months ended June 30, 2012
Total revenues	$438.9 million	$193.0 million	$1.174 billion	$792.7 million
Income before taxes	$184.8 million	$28.7 million	$224.3 million	$44.8 million
Net income	$120.1 million	$18.8 million	$146.1 million	$29.2 million
Diluted EPS	$1.71	$0.30	$2.09	$0.46
Operating income	$30.3 million	$27.4 million	$63.7 million	$57.1 million
Net cash from operating activities	Not separately provided	Not separately provided	$491.3 million	$500.4 million

Net income margins were approximately 27.4% in Q2 2013 versus 9.7% in Q2 2012, and 12.4% for the first six months versus 3.7% in the prior-year period. Net income benefited materially from favorable derivative and embedded-derivative fair-value changes and should not be viewed as entirely representative of recurring operating performance.

Annuity deposits: Net deposits after coinsurance were $1.091 billion in Q2 and $1.978 billion year to date, up 23% and 12%, respectively, from the comparable periods.
Investment spread: 2.70% in both Q2 periods and 2.70% for the first six months of 2013 versus 2.81% in the first six months of 2012. Management’s stated target was 3.00%.
Net investment income: $336.1 million in Q2 and $665.8 million year to date, up 5% and 3%, respectively. Average investment yields declined to 4.94% and 4.98% from 5.34% and 5.47%.
Assets and equity: Total assets were $37.289 billion at June 30, 2013, up from $35.133 billion at December 31, 2012. Stockholders’ equity declined to $1.442 billion from $1.720 billion, primarily because accumulated other comprehensive income fell to $244.3 million from $686.8 million.
Liquidity: Cash and cash equivalents were $746.9 million, down from $1.269 billion at year-end. Operating cash flow was $491.3 million, while investing activities used $2.377 billion and financing activities provided $1.364 billion.
Debt: Balance-sheet notes payable were $303.1 million, subordinated debentures were $246.0 million, and repurchase-agreement borrowings were $160.4 million. The revolving credit facility had $15.0 million outstanding at June 30.
Investment portfolio: Investments totaled $29.053 billion, including $25.622 billion of fixed maturity securities and $2.584 billion of mortgage loans. Approximately 94% of fixed maturity securities were investment grade under NRSRO ratings.

Material Changes Versus the Prior Comparable Period

Total revenues and net income increased sharply, driven principally by a $214.9 million favorable swing in derivative fair-value changes in Q2 and a $329.7 million favorable swing for the six-month period.
Interest-sensitive and index-product benefits increased to $336.0 million in Q2 from $142.7 million, primarily because index credits increased to $241.8 million from $50.7 million.
Amortization of deferred sales inducements increased to $120.5 million in Q2 from $25.9 million, and deferred policy acquisition cost amortization increased to $169.3 million from $44.8 million, reflecting business growth and fair-value accounting effects.
Comprehensive income was a loss of $297.3 million in Q2 and $296.4 million for the first six months, despite positive net income, because of significant unrealized investment losses. Accumulated other comprehensive income declined by $442.5 million year to date.
Gross unrealized losses on investments increased to approximately $545.3 million at June 30 from $83.9 million at December 31, 2012, primarily due to higher Treasury yields. Management stated that substantially all affected securities were current on principal and interest payments.
Operating income, management’s non-GAAP measure, increased 11% in Q2 and 12% year to date. It excludes realized investment gains and losses, derivative fair-value changes, debt extinguishment losses, and litigation-reserve changes.
Commercial mortgage-loan credit metrics improved in several respects: nonaccrual or collateral-dependent principal declined to $15.3 million from $34.7 million at year-end, and mortgage-loan impairment losses declined materially from the prior year.

Guidance, Outlook, Commentary, Risks and Unusual Items

Management expected the company to reach a fully invested position by the end of the third quarter of 2013 as excess cash and short-term investments were deployed.
Management intended to continue reducing policyholder crediting rates, where permitted, to move the investment spread toward the 3.00% target. Approximately 0.60% of additional rate-reduction capacity remained before minimum guaranteed rates would be reached across the entire book.
Low interest rates create reinvestment and spread-compression risks, while rising rates can reduce the fair value of available-for-sale securities. A modeled 35-basis-point increase in rates was estimated to reduce fixed-maturity fair value by approximately $780.9 million and stockholders’ equity by approximately $227.6 million.
Derivative and embedded-derivative valuations are highly sensitive to equity-index performance, interest rates, option costs, policy persistency, and discount-rate assumptions. A 100-basis-point increase in the embedded-derivative discount rate was estimated to reduce the liability by $240.7 million, with related effects on deferred cost amortization.
Other-than-temporary impairment losses recognized in operations were $2.8 million in Q2 and $6.0 million year to date, compared with $1.0 million and $3.9 million in the prior-year periods.
Other operating expenses included an $8.5 million guaranty-fund assessment related to the insolvency of Executive Life Insurance Company of New York.
The company had a recorded $17.5 million litigation liability for the Los Angeles annuity-practices class action. A settlement agreement was entered into on July 30, 2013, but remained subject to court approval and an uncertain claims process.
On July 16, 2013, the company issued $400 million of 6.625% senior unsecured notes due 2021. Proceeds were intended to fund potential purchases or exchanges of the 2029 and 2015 convertible notes, repay the revolving credit facility, and pay related costs. The revolving facility was repaid on July 17, 2013.
Unfunded commitments at June 30, 2013 included $93.8 million for commercial mortgage loans, $31.5 million to private-equity limited partnerships, and $29.3 million to secured bank loans.

Most Important Facts for Investors to Verify

Confirm the issuer identity, because the supplied filing is for American Equity Investment Life Holding Company rather than American National Group Inc.
Separate recurring operating income from GAAP net income, particularly the large derivative and embedded-derivative fair-value effects.
Monitor investment-spread trends, reinvestment yields, policyholder crediting rates, and the company’s remaining ability to reduce those rates.
Review the $545.3 million of gross unrealized investment losses, including exposure to interest-rate-sensitive, corporate, mortgage-backed, and international securities.
Assess liquidity and capital after the July 2013 $400 million debt issuance, repayment of the revolving facility, and any proposed convertible-note tenders or exchanges.
Track the court approval and ultimate claims cost of the Los Angeles litigation settlement.
Evaluate sensitivity to interest rates, equity-index performance, option costs, policy persistency, and credit deterioration in the commercial mortgage portfolio.