Good morning, welcome to the FGL Holdings second quarter 2019 earnings conference call and webcast. All participants are in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your telephone keypad. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to Wes Carmichael, AVP, Corporate Development and Investor Relations. Please go ahead.
Thank you, Debbie, good morning, everyone. We appreciate you joining our earnings call. Today we will discuss our financial results for the second quarter of 2019, which ended on June 30th. You can find the financial information for FGL Holdings on the investors section of our website, fglife.bm. Today's presenters include Chris Blunt, President and Chief Executive Officer, Dennis Vigneau, Executive Vice President and Chief Financial Officer. Some of the comments we make during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. We do not intend to update any comments on this call to reflect new information, subsequent events, or changes in strategy. A number of risks and uncertainties exist that could cause our actual results to differ materially from those expressed or implied.
We discussed these factors in detail in our 2018 10-K that we filed with the SEC on March 1st of this year. During this conference call, we may refer to non-GAAP financial measures that we believe may be meaningful to investors. Please refer to our second quarter earnings release, financial supplement, and investor presentation that we posted to our website. These documents contain a reconciliation of non-GAAP financial measures to GAAP. Finally, all comparison comments today will be to the second quarter of 2018, unless we state otherwise. I'll now turn the call over to Chris.
Thanks, Wes. Everyone- increased 12% to $65 million or $0.30 per share, adjusted operating ROE increased to 18.3%. Results for the quarter also included a heightened level of project-related expenses of roughly $0.05 per share, which Dennis will touch on. Average assets under management grew 6% over the first quarter to $27.4 billion, reflecting strong new business volumes from our retail channel and accelerating growth at F&G Re. We also increased net spread by nine basis points over the first quarter to 2.26%, demonstrating pricing discipline while increasing investment yield. Finally, our capital position strengthened further with an estimated RBC ending the quarter at approximately 475%. We currently estimate $300 million of deployable capital. Now with respect to sales, momentum continues and our market share is growing.
Total annuity sales were up 46% to $1.1 billion, setting company records for both total annuity and FIA sales. That said, our focus is on maintaining spread margins. Given the steep declines in interest rates during the quarter, we responded quickly and appropriately to adjust pricing to achieve targeted returns. A distinguishing characteristic of our business is our ability to regularly adjust pricing in line with environmental conditions. We would expect some impact on the level of sales in the second half of the year, but still expect to finish the year with double-digit sales growth in annuities. F&G Re, our Bermuda reinsurance platform, continues to increase its profile as a leading reinsurer for spread liabilities. F&G Re executed on a $900 million block acquisition of fixed annuities and generated $104 million of flow deposits in the quarter, doubling prior year flows.
F&G Re continues to increase its profile as a go-to reinsurer for spread liabilities and is an important alternative for cedents seeking to diversify from several of the larger incumbents. Our success in block and flow reinsurance, combined with significant organic retail growth, highlights the strength and growing diversity of the franchise. In addition to existing channels, we have a number of other opportunities to further enhance our distribution footprint. As always, we will continue to actively pursue attractive and meaningful M&A opportunities. In terms of investment results, we continue to increase our net investment yield as we reposition the portfolio. The net investment yield was 4.6% in the quarter, up 13 basis points over the first quarter, despite the recent decline in interest rates. More importantly, we not only maintained but actually increased our spread margin in the quarter.
Page eight in our earnings presentation shows that we've maintained consistent margins over a period of years amidst a lower-for-longer interest rate environment. Because our core products are tightly matched from an ALM perspective and can be repriced regularly, we have the ability to respond quickly to even the most volatile interest rate environment. In addition, our unique partnership with Blackstone is a competitive advantage given the fact that they are both an originator of private credit as well as a manager. In fact, we believe Blackstone's ability to source private credit will be even more valuable in a low-interest rate environment. Regarding portfolio construction, we continue to increase our allocation to alternative assets. Funded alternatives increased to $912 million or 3.4% of the portfolio as of June 30th. Great progress there, and we're now planning on exceeding the previously targeted allocation of 3.5% by year-end 2019.
In terms of credit quality, our team continues to strengthen our overall credit risk profile by allocating away from higher-risk assets such as BBB-rated corporate bonds. Given our unique asset sourcing capabilities and the predictable nature of our liabilities, we can prudently assume more liquidity risk as opposed to credit risk at higher yields relative to our peers. Beyond investment management, our core shareholders, Blackstone, CC Capital, and F&G continue to be tremendously supportive in the development of our company. We see our core shareholders as key partners as we position ourselves to build a bigger and better F&G. We also strengthened our team during the quarter and have added many professionals across varying departments, including senior additions in HR, operations, actuarial, and corporate development. Our new F&G colleagues have deep experience across the industry.
In summary, F&G is a great growth story across multiple dimensions, including top-line growth, margin expansion, and an industry-leading ROE. Given our high growth rate and reputation as a great place to work, we continue to attract the industry's top talent. With that, I'm going to now turn the call over to Dennis to discuss our results in more detail.
Thanks, Chris, and good morning, everyone. Today, I'll focus my comments on the following: the earnings and performance trends across the business, results in the investment portfolio, then I'll wrap up with where we stand on capital heading into the second half of the year. Our Q2 earnings reflect ongoing execution on our strategic priorities, including the following. We closed a signature win for the Bermuda entity, a $900 million block reinsurance transaction with a highly rated mutual insurer. We delivered organic top-line annuity sales growth of 46% year-over-year, ahead of the overall market, with strong results in both FIA and MYGA product lines. Net investment income and overall yield lift continues as the portfolio reposition benefits continue to emerge even amidst the challenging interest rate environment.
These benefits, combined with discipline in force management, are translating nicely into expanding net investment spreads, reported earnings growth of 12% over the same period last year, and an overall adjusted operating ROE of 18%. With those highlights as a backdrop, let me get into a few more details. We reported adjusted operating income available to common shareholders of $65 million or $0.30 per share, compared to $58 million or $0.27 per share last year, an increase of 12%. The underlying core earnings available to common shareholders were $69 million after adjusting for $4 million of net unfavorable items that while core to our overall operating performance are not consistent period to period.
The notable operating items are as follows: $11 million of the exploratory M&A expenses mentioned earlier, of which $7 million-$8 million or about $0.03-$0.04 per share should be viewed as unusually high. These project expenses were partially offset by $4 million of favorable market movement on futures that we use to manage policyholder behavior in the FIA product line and $3 million of favorable mortality experience in our SPIA product line. On a sequential basis, last year's second quarter AOI of $58 million included a net $6 million of favorable items. Let me add some further color on the unusually high level of project costs in the quarter. As we've articulated previously, executing on accretive M&A opportunities is a core element of the strategy.
Since the merger in 2017, we've typically incurred on average about $3 million or so of expense quarterly as part of those efforts. In the current quarter, due to the number and complexity of deals that we assessed, the level of expense was higher at $11 million after tax. Looking ahead, based on our current pipeline, we'd expect this quarterly spend to revert to more typical levels. Adjusting for these lumpy notable operating items in both periods, we had a very strong second quarter, with core earnings increasing $17 million or 33% over the prior year. This uplift in AOI continues to be driven by ongoing invested asset growth, the benefits of the portfolio reposition lift, disciplined operating expense management, and improving underlying trends in net spreads. We ended the quarter at a book value per share excluding AOCI of $7.31, up 2% from $7.15 reported last quarter.
Turning to the investment portfolio. Overall, it is performing well due to significant reposition activities we completed in 2018 and the continued funding of our alternative asset portfolio. Average assets under management for the six months totaled $26.7 billion. Reflecting an increase of $1.7 billion net asset flow year-over-year and a stable in-force book. This reflects growth of 6% net of reinsurance transactions. Fixed income asset purchases during the quarter totaled over $2 billion at a weighted average NAIC rating of 1.5 and an average net yield of 4.75%. These purchases were primarily investment-grade corporate constructed securities such as CLOs, mortgage-backed securities, and ABS. The higher level of purchases in the quarter reflects both new money flows and some repositioning, including putting to work the proceeds from the sale of $500 million of BBB-rated corporates we spoke of last quarter.
As interest rates and spreads have narrowed, we see a further opportunity to de-risk our BBB portfolio with another $500 million reduction. We have already made significant progress with over half of those sales executed to date. Proceeds from those sales will be reinvested in higher quality corporate and structured assets. In terms of other repositioning activities, we've been working on some additional actions this year, which we expect will achieve $15 million on a run rate lift basis overall once completed. We saw approximately two and a half million of uplift in the quarter from these reposition actions. We also continue to build our allocation to alternative assets. This program is making real progress with approximately $900 million or 3.4% of the portfolio currently funded in alt assets with a further $1.1 billion of unfunded commitments yet to come.
We expect alternatives to be funded at about 3.8% of the portfolio by year-end, slightly ahead of our original expectation. Ultimately, we'll build to an overall 5% allocation with future timing aligned to achieve profitability and in line with our capital target. On average, we are assuming a net 12% return for this asset class over the life, and year-to-date, the annualized return on alts was about 10%. Next, turning to net investment income and yield. Compared to the first quarter of 2019, net investment income was $315 million, an increase of $26 million this quarter. This primarily reflects a $12 million lift from repositioned and alternative assets, $9 million of organic asset growth, $8 million from the reinsurance transaction we closed in the quarter, all of which were partially offset by $3 million lower earnings on our floating rate portfolio.
Overall, the reported GAAP earned yield was 4.6% in the quarter, up from 4.47% last quarter. Looking ahead at the current interest rate levels, we would expect the 4.6% yield as of 2Q to hold for the remainder of the year. It is important to note that we will remain disciplined on our investment strategy and risk tolerances and will not chase yield at the expense of credit quality should interest rates continue to decline. While the overall reported yield is an important element of the business, it is just one aspect of profitability. What is most important is that as interest rates fluctuate, which they have and will continue to do, we actively manage our net investment spread. It is net investment spread and not simply the investment yield that ultimately drives earnings and attractive returns on capital.
To this point, we have an established track record of maintaining our pricing discipline through various economic cycles, as shown on pages eight and nine in the earnings presentation. The stability and expansion of our spread is a function of our core FIA product characteristics, whereby we can regularly adjust crediting rates on our in-force and new business to manage across any interest rate environment. It's also important to note that our cost of hedging has been consistently stable over the same period of time. This quarter is a great example as we were able to expand spreads amidst the decline in rates. Net investment spread for all products is up and in our core product line, FIAs is at 284 basis points, up 30 basis points from the prior quarter.
The increase here is a function of the portfolio reposition lift, in particular the alternative asset portfolio, which saw higher earnings in the quarter. The portfolio reposition lift, combined with active new business pricing and in-force management, allows us to effectively manage that net spread. We further benefit from our stable and predictable book of in-force liabilities, as shown on page nine in the earnings presentation. F&G is largely a fixed indexed annuity and fixed rate annuity provider, and we have a relatively young book. Over 85% of the book is surrender charge protected, and the distance to the guaranteed minimum crediting rate is 85 basis points. We're also very tightly matched between asset and liability cash flows with an average seven-year weighted life.
When you bring it all together, these stable, well-priced liabilities drive our asset allocation mix, which combined with Blackstone's asset sourcing capabilities, provides a real competitive advantage. Let me wrap up with a few thoughts on capital and liquidity. We finished the second quarter in a strong and stable capital position with an estimated risk-based capital or RBC ratio of 475% on a consolidated basis, reflecting strong statutory earnings and a net reinsurance capital benefit. Next, with regard to deployable capital, at the quarter end, we had about $300 million comprised of insurance company surplus, available debt capacity, and holding company assets. Furthermore, we have a $250 million revolver that is undrawn and another $1 million-$200 million of readily available capital through established reinsurance relationships. Finally, turning to share repurchases. Since the program was announced in December, we've utilized $35 million out of our $155 million repurchase authorization.
Repurchases in the quarter were minimal given the exploratory M&A activity that I mentioned, which kept us out of the market for our shares. We expect buybacks to accelerate in the third and fourth quarters. In summary, we have great momentum across the business and delivered a terrific second quarter. With that, I'll turn the call back to the operator for questions.
We will now begin the question and answer session. Thank you. Pardon me. All participants will be in listen-on. Okay, we will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we'll pause a moment to assemble our roster. Our first question comes from John Barnidge with Sandler O'Neill. Please go ahead.
Just some commentary trajectory of net investment spreads in the current environment. I know you just provided color on expected net yield on assets, but maybe commentary around new money yields in 3Q19 to date, as well as what your expectation for utilizing the crediting rate flexibility that you have.
Good morning, John. It's Dennis. How are you?
Thank you.
Great question. As we look forward, first, as you think about the 460 yield, as I mentioned, that's an important element of it, and assuming everything stays current in the interest rate environment, we feel pretty good about that 460 heading into the end of the year. In terms of the new money rate, clearly over the last couple of weeks, rates have come down. We did put money to work at 475 in the quarter. I would expect we'd put new money to work at a lower rate in the third and fourth quarters, assuming rates stay where they are. Again, it's important to remember that we reprice new business monthly. We're always working towards a net spread when we put new business on the books. In terms of the in-force, that tends to be a pretty stable book. We're well matched.
In terms of how we'll utilize the room to the floors in terms of adjusting caps and interest credited rates, we don't have a formulaic approach to that. We review it each month, the in-force profitability and what money and assets we see maturing, what liabilities are maturing, and we make that decision and review it in depth each month. It's far more art than science on that front. We take a long view on the management of that book. I would think of it as we strive to keep that book stable in terms of the stickiness of the liabilities.
The next question comes from John Nadel with UBS. Please go ahead.
Thanks. Good morning. Maybe you guys could take a couple bucks next quarter and do something about the conference call. Anyway. Dennis, the alternatives discussion. A 10% annualized return on a year-to-date basis. I'm guessing, but maybe you can help us with the progression of that. I'm guessing first quarter was much weaker than that, second quarter much better. Maybe you can help us think about the difference, disparity between one and 2Q, as well as maybe think about the progression as these investments season over time.
Sure. Good morning, John. Can you hear me okay?
Yeah, it's better now. I'm not sure what was going on earlier, but it sounded like you guys were in traffic.
Okay, great. Thanks for the question. When you think about the delta in the first quarter versus second quarter for alternative income, and I think we talked about this last quarter, we had about a 6%-7% annualized return on alts in the first quarter.
Got it. Okay.
We were probably around slightly north of 10%, 11%, 12% in the second quarter, clearly better. That all blended down with additional fundings to about a 10% overall at the half-year mark. I would suggest, and although we're targeting a 12% lifetime, this is still a pretty young book. We've only been really putting money in the ground and putting it to work since the, say, third and fourth quarter of last year. We feel good about what we're seeing in the second quarter. I would still expect in these early years as we add fundings, that average annualized return could come down just because we're putting new money to work that's going to be lower. In the later years, as you know, the returns will be above that lifetime of 12%.
If I was going to gather a guess, I'd say given the additional fundings, we expect this year to get to 3.8%. That 10% at the half-year mark will likely come down on an average basis. I'd think of that more for this year, maybe back to around the 7%-8% on a fully funded book at the end of the year, that'll continue to climb as we go forward.
Got it. That's perfect. That makes an awful lot of sense to me. Okay. The annuity transaction, maybe put that in some context, the $900 million block that you guys did. Maybe you guys can put that in some context with respect to, it clearly sounds like you were very busy during the quarter, that it was an elevated sort of opportunity set. How does the $900 million transaction that actually did get done compare with sort of the range of opportunities that you were looking at?
Yeah. Great question. The $900 million block, very pleased to have gotten that done. Importantly, that's in our Bermuda platform, which although that platform's still growing over time as we achieve that growth, we're going to start to see nice improvements in lowering of our effective tax rate as we've talked in the past.
Yep.
We're very pleased to have gotten that transaction done. That deal relative to the rest of the pipeline, it was at the smaller end of the spectrum. The deals of other items and opportunities that we assessed were larger, much larger, more complex. This was a fairly straightforward reinsurance deal with a highly rated mutual carrier. It's very plain vanilla liabilities, right? These are deferred annuities, very predictable. We've got deep experience here. It was a fairly straightforward transaction. The others were, as I said, larger, more complex. You will see us have some additional expense each quarter, but reverting more back to historical levels there.
And then-
Hey, John, this is Chris.
Hey, Chris.
Just one bit of color to add on to that. I think, if we look at the pipeline now going forward, I'd say probably more robust opportunities around potential flow opportunities as opposed to bigger scale transactions.
Got it. That's helpful. Then sort of related to this last line of discussion. Dennis, you mentioned in your prepared remarks that the pace of buybacks is likely to pick back up in the back half of the year. Would you characterize that more as a result of the opportunity set being somewhat diminished, or is that more a result of, boy, we've seen a lot of pressure on stock prices and valuation, and the return characteristic of buyback has just improved so much?
Yeah. Great question. Let me break down in a couple of ways, because there's multiple drivers here. When we put that authorization into place, and certainly in the first quarter, we were able to utilize that effectively and bought back about $35 million to date. We continue to believe that our stock is fundamentally undervalued. We put that authorization in place to utilize it, to deploy it in a purposeful way after December. If we weren't deeply engaged in these potential M&A transactions in the second quarter, we would've been in the market buying our shares. I just want to make that very clear.
Gotcha.
That probably would've been at the level that you saw in the first quarter. We'll be back in the market here in the second half of the year, and I think you're going to see the activity pick up there nicely. I think of it as the share repurchase is one aspect that we're engaged on to deploy capital, and then M&A, which we have additional capital for is a separate sort of pool and bucket.
Got it. Thanks so much.
Yeah, you bet.
The next question is from Pablo Singzon with J.P. Morgan. Please go ahead.
Hi, good morning. My first question was I was wondering if you could provide more color on the reinsurance block that you assume. In terms of financial metrics like capital that the block consumed, any earnings contribution, and also if the assets were fully repositioned this quarter.
Hey, good morning. It's Dennis. The block itself was just about $900 million, slightly more of fixed annuities, plain vanilla. We'd expect this block to run off over the next several years, both generating a nice double-digit return as well as that block runs off it'll free up the capital that's been deployed. The capital, when you think about it, there's a couple of different pieces, and it's in Bermuda, you've got a ceding commission that we pay to the ceding company. We think that was an attractive and competitive from our perspective, while still allowing us to achieve our target returns, which are double-digit. We've not disclosed that. I'm not prepared to disclose that this morning, but we're very comfortable with the ultimate double-digit return that we expect to achieve. We have not completed the reposition. That's underway, and we expect to get that done shortly.
At just $900 million, very confident that we'll hit those targeted returns. Blackstone's doing a nice job thus far on moving that money around.
Got it. Thanks. My second question was, the second quarter was clearly very active on the M&A front for you guys, and you ultimately closed on one deal. I was just wondering if you can comment on the nature of the competitive environment for block deals. Also, if you could talk about the various considerations and dynamics that ultimately led you to this deal after looking at other opportunities.
Yeah. Maybe I'll start here, then Chris can certainly share his perspective. The pipeline on the block deals looks pretty good. We've got a number of opportunities with a variety of partners that we're looking at. They range from block deals to, as Chris mentioned, a lot of opportunities in terms of new flow deals that we think are very attractive. We have a couple of deals already in place. We did mention we had $104 million of flow come in in the quarter. That business is growing quite nicely. We feel good about the activity there. In terms of the deals that we didn't close on, I think was the second part of your question. Look, it's real simple why we didn't close on the deals.
After our deep and extensive review, in terms of the businesses that we were reviewing, they just didn't meet our financial hurdles in one form or fashion or another. In some of them, there were multiple factors that at the end of the day, we decided not to move forward. In others, it's as simple as the return, and for others, it's structural and/or the nature of the liabilities in light of the interest rate environment we're in. We just didn't move forward. The pipeline looks good, and we'll continue on that front. Chris?
Yeah. The only thing I'd add is I don't personally view it as it's any more competitive than it's been for a while now. It's not like we're seeing crazy activity that we think causes us to want to just pull out of the market. I think there's still plenty of opportunities, as Dennis said, particularly as you get into some of the more complex transactions. There's just a lot of moving parts that have to work for both sides to get it done. I don't think there's too much we can read into that other than obviously it's disappointing to devote resources to deals and not get them over the goal line.
Okay. Maybe one more before I re-queue. I think, Dennis, there was an outward reinsurance session this quarter. Can you just talk about any impact on earnings from that and maybe any impact on capital as well? Thanks.
Sure. We did reinsure. As I've mentioned in the past quarters, we've got a relationship with a couple of reinsurers. We had an opportunity at attractive pricing to do another tranche of ceding here, about $750 million of FIA reserves and $250 million of fixed annuities. We've got very attractive pricing there, effectively paying a risk charge on required capital for the assuming company. It's very attractive. It's similar to what we did at the end of the year. In terms of the impact on earnings, pretty nominal. Maybe $1 million or so per quarter pre-tax. It's quite attractive reinsurance, and the overall impact of that was we freed up about $80-plus million of capital at the end of the day.
Okay. Thank you.
Yep.
The next question comes from Andrew Kligerman with Credit Suisse. Please go ahead.
Andrew Kligerman. Okay. Thank you. Just a little more granularity around these M&A transactions that you may have missed. I'd be so curious as to the types of, you mentioned complex. Were they LTC? Was there LTC tied to it? Was there variable annuity blocks tied to it? What were those complexities? Maybe how big were the deals, and how many competitors were involved when you went out there? Was it an auction process? Maybe you could provide a little granularity around that. It would be very helpful.
Yeah. As you know, as part of these transactions, there's all sorts of requirements around non-disclosure. I think it would be out of character for us to comment with that level of specificity. What I will say, and you should take from this some comfort, is they didn't fail because we were trying to figure out how we could acquire long-term care or variable annuity type assets. Those really aren't in our wheelhouse. As we've said, we're much more interested in things that we've got a deep experience in and don't have the volatility or the earning characteristics of those types of product lines. They were large, much larger than the $900 million. Certainly comfortable sharing that. Several billion dollars, double-digit billion dollars in terms of size, and I guess I'll leave it at that.
There were a lot of bidders?
Active, engaged M&A type processes. Yes.
Okay. With respect to the spreads, and it was getting very staticky on that earlier question, and you were touching on the 80, 85 basis points of flexibility around the guaranteed minimum rate. Now you've kind of guided down in terms of your net investment income yield. Should we take the message to be that the 226 basis points of spread that we saw in the quarter is very sustainable over the intermediate term, despite the pressured interest rate environment?
Yeah, great question. I would look at the 226 basis points of spread and the 284 on FIA. Assuming the current interest rate environment sort of stays where it is right now, as pretty sustainable. Although we'll be putting new money to work at a lower yield, and quite frankly, that's part of the change from 475 to 460 is we're just putting new money to work at a lower rate. We also adjust new money pricing every month, so that all gets washed out in the net spread. We feel assuming a static and stable interest rate environment, the 460 looks good. We have some positive factors. New money that we've put to work at rates above the current portfolio yield in this and earlier quarters earning in.
The continued maturity of the alternative asset portfolio is also going to help sustain that yield as we go forward. It's not to say there's not some headwinds. If you think about our floating rate portfolio, we've got about $3.5 billion-$3.7 billion of floating rate assets. With the drop-down in rates, there'll be some earning pressure on that part of the portfolio. If you look at the rest of the portfolio, it's chugging right along and on an all-in consolidated basis, feel pretty good about the 460 at this point. Again, in the current environment.
If I could just ask one more. On total sales, up 49% year-over-year. Even sequentially, it was up 10% in this very tough rate environment. FIAs, MYGAs, they look terrific in terms of the growth. Do you see that kind of growth going forward over the next few quarters?
Yeah, great question. We did have a terrific tailwind coming out of 2018 in terms of sales momentum. Up strong double digit as you describe. I will note that we're achieving or exceeding our targeted lifetime returns on that business. At the end of the day, we'll take top line growth, we've demonstrated over the years we're very disciplined. We'll also forego top line growth if we can't achieve our margins. As you look forward, we had come into the year estimating that we'd be in low double digit in terms of overall annuity growth for the year. We still feel good about that number. We're high in the first half. You'll see that momentum come down with pricing actions that we've taken in the second half, or rather actions in the first half that will slow the sales growth in the second half.
I think we should still feel very good about the double-digit sales growth for the year.
So maybe-
If I might add just two. I'd just add two things to both of your good questions. One, I do think we'll see a little bit of a slowdown second half, as Dennis said, in terms of sales. I would then say, though, as we head into 2020, that is, I think where some of our channel expansion activities should start to kick in around independent broker-dealers and banks. From a growth rate perspective, yeah, I think probably slowing closer to an industry growth rate in the second half. Our expectation would be that as we expand through different channels next year, that we'd see an acceleration of that growth.
To your first earlier point, I think this is the billion-dollar question for this company, and I think it's our biggest personal frustrations is the movement in rates as the stock gets treated as though we have these gigantic legacy books of variable annuities and no-lapse guarantee. The reality, as Dennis said before, it is a very young book, largely of fixed index annuities and multi-year guaranteed annuities. That track record, that one slide in the earnings presentation, I think it's number eight you see that despite crazy gyrations in Treasury rate this company's ability to predictably, consistently deliver net spreads. I think that's our story, and that's why we believe the stock is quite undervalued.
Got it. Thanks so much.
The next question is from Alex Scott with Goldman Sachs. Please go ahead.
Hi, good morning. I guess I just had a question going back to the cession. When I think about the reinsurance transaction of $900 that you did and the reinsurance cession that you also did how accretive on a net basis will those two transactions be? I guess you should get a nice help on the tax rate, I would think. Can you help us think through what the net impact is?
Yeah. Disclosing too much, which we haven't done in the past on the pricing of the cession that we did, the $1 billion. Two very different types of transactions. One is we're effectively ceding off reserves or our own book FIAs, basically for a risk charge on the required capital that the assuming company has. It's very low-cost reinsurance, very efficient, very low single-digit type cost. We're targeting a double-digit return on the business that we've assumed. We get to free up capital on the first block, think about that, still retaining the economics above the risk charge that we pay.
We get to free up that capital, redeploy that at a double-digit targeted return into things like what we just picked up from the ceding company, the $900 million, and make a really nice spread, effectively retaining the net profits on the original block, and then picking up a double-digit return on that redeployed capital. The returns are phenomenal. We want to do more of this, and we'll do it as the opportunities present. Does that help?
Yeah, that's very helpful. The follow-up question I had is just on the comments on interest rates. Appreciate that the earnings power, you have a lot of levers, and the earnings power has been resilient. I guess the one place that I've considered as being maybe a little more exposed to rates, I know it's not anywhere near some of these legacy books that others have. The rider, I guess, when I think through the rates and when I think through adjusting cap rates down and what that does to sort of the progression of account balances over time, will any of that have an impact on how much of earnings need to be put behind accruing into the rider reserve when we think about your actuarial review?
Yeah. Good question. When you think about the reserving for riders, you've got just the FAS 133 reserve. Those impacts. First and foremost, we still believe in the ultimate pricing assumptions when we wrote the in-force book. The book remains solid. The assumptions continue to play out well inside of our pricing parameters. We'll be looking at that in the third quarter. Yes, to the extent there are declines in interest rates, there can be adjustments to the reserves related to the riders. It goes through our GAAP earnings. It doesn't go through adjusted operating income. We would view that as normal fluctuation due to marking the portfolio each period based on where interest rates sit.
If you look back at the history of rates and the impact on FAS 133 and other aspects, it does tend to bounce around, and there's nothing coming through our product experience that gives us anything to be concerned about.
Okay. Thank you.
There will be accounting noise, we feel just fine about it.
Got it. More accounting noise, not necessarily outsized impact of any kind on go-forward earnings.
Yeah, that's right. I'll also note, for much of the in-force book, we also have separate reinsurance transactions that have reinsured off that GMWB rider risk as well.
Got it. Okay. Thank you.
Yep, you bet.
Next, we have a follow-up question from John Barnidge with Sandler O'Neill. Please go ahead.
Thank you. Would you consider pursuing an accelerated share repurchase as opposed to just open market purchases, given maybe the blackout periods you have when you're pursuing transactions?
Hey, John. Great question. We'll certainly review that as well as putting in place open market or 10b5-1 type plans as we get past the blackout window here. Great question.
Okay.
It's on the consideration list.
All right. Surrender activity declined during the quarter, is now at the lowest level since 3Q18. What's your expectation for surrender activity, maybe the balance of the year just going forward?
I would say it probably will be a little bit lower and consistent with the current quarter relative to prior quarters where it may have been accelerating given better equity market performance. When there is volatility, customers and policyholders do tend to hunker down. Actually, equity market volatility, I think we've talked about this in the past, tends to actually spur new business as people start looking at their equity market account balance statements. If rates continue and equity markets continue to have the volatility we've seen over the last few weeks in the second half, I would expect surrenders would stay at the lower rate that we just saw in the second quarter.
Okay. That's great. My last question, how much business has come from partnerships added since the ratings upgrade in November? Of those new partnerships, how much more capacity or room to run do you think there is? Thanks for the answers.
Hey, John, it's Chris. Great question. I would say, avoiding exact specific percentages here. We do track the number of new producers. That number keeps increasing of new folks selling F&G products for the first time. That's obviously an encouraging trend. I think we feel great about who our top core partners are. I would say it's probably more a function of going deeper with some of our key partners as opposed to adding lots of other partners to the mix, which is something that we also feel good about because you want it to be truly strategic and not just opportunistic distribution types of opportunities. I'd say the health, when you get underneath the surface of just looking at the gross sales and look at where the business is coming from, number of new producers, depth, we feel really good about.
It's still a very big market. Forgetting all the new channels we can go into, if you said just stay within the world of IMOs, we still see a lot of upside and opportunity to grab share. The last thing I would say, we've talked about this before, the top IMOs that we market through and partner with, they themselves have really evolved their businesses in an incredibly impressive way over the last few years and are now delving into independent broker-dealer channel banks, RIAs, et cetera. We are today, as we speak, already starting to access some of those broader channels simply through the existing partners that we market through.
Thanks for the answers.
Next, we have a follow-up question from Pablo Singzon with J.P. Morgan. Please go ahead.
Pablo, are you on mute?
I'm on mute.
The next questioner can please go ahead.
Oh, hello. Sorry. Hi. Can you hear me?
Yeah, we can hear you.
All right. Sorry about that. Dennis, just to follow up on your comments regarding the lower portfolio yield. Do you expect to fully offset the 15 basis points delta with the crediting rate actions? If so, should we expect a lag for when those actions flow through? I think your historical practice has been to adjust rates faster, at least compared to your competitors.
Yeah, great question. I think you got to break down that 15 basis points difference between the 4.75% and the 4.6% that we're estimating now into a couple of pieces. Part of that is just new money. We're putting new money to work at a lower rate. We offset that when we price new business, so we don't need to offset any of that with active in-force crediting rate action. The other handful of basis points, again, as I said earlier it's more art than science. We look at the book each month when renewals come up. We look at the overall estimated profitability, how each block has been performing. Sometimes we'll take an action, and other times we won't. At the end of the day, and some of that just depends on persistency and where that's running.
Oftentimes to the earlier question, to the extent we have greater persistency we're going to earn more given the nature of these liabilities. That's a balancing lever that we can use to avoid taking a crediting rate action. It's a blend of a number of factors, but to be clear if needed we do take crediting rate actions to protect the net spread and drive overall targeted returns.
Okay.
Pablo, the only thing I'd add to that is Blackstone's been doing a great job of opportunistically sourcing, continuing to source attractive investment-grade opportunities. It's another reason I know some folks have talked about shying away from the MYGA market. We love it. It's been very consistent for us, largely because we're still only $27 billion of AUM. Blackstone's got this incredible capacity to source interesting investment-grade private credit with attractive yields, and that, particularly in the shorter duration end of the spectrum, that just lends itself perfectly to the MYGA market. It's helped, and it's taken a little bit of the pressure off having to make those tough trade-offs between policyholder benefits and meeting your return target.
Got it. Thanks for those comments. Just the last one how much of an earnings offset do you think F&G's reinsurance transactions will be to the drag from lower yields or perhaps even spreads, at least versus where we were a quarter ago?
Pablo, is your question how much is F&G Re contributing to earnings?
It's more if you think about the model a quarter ago, at least my model, I wasn't assuming a $100 million block deal. Right? It seems like you expect some accretion from that. I was just wondering, is there a way to frame that accretion versus the potential drag from lower yields or spreads moving forward?
It's a fair question. On the fly, I'd hesitate to just rattle something off. Maybe we can track that one offline. What I will say is very low cost of capital on what we ceded out and double-digit returns on the $900 million that we ceded in. Plus, we free up the capital and retain the net profits on what we send off. Hopefully that framework helps, and we can always follow up offline.
Okay, sounds good. Thank you.
Ladies and gentlemen, this will conclude our question-and-answer session. I will now turn the conference back over to CEO Chris Blunt for closing remarks.
Great. Thanks, everybody, and appreciate the good questions. Just a couple of closing comments here. Obviously, the first half of 2019 produced solid financial results. Year-over-year sales growth was 43% first half to first half, a strong 24% increase in AOI, 300 basis points of ROE expansion. As Dennis mentioned before, we've got strong capital position with $300 million of deployable capital that we're going to allocate toward the most attractive form of deployment. Those opportunities are going to include continued organic growth, attractive and meaningful inorganic opportunities, and obviously share repurchases. More importantly, I believe we're now headed into an environment that's actually going to showcase the strength of our business model, the competitive advantages of our platform, and the unique capabilities of our sponsor group, all of which we believe should lead to continued outperformance. Thank you again, and appreciate you tuning into the call.