Good afternoon, ladies and gentlemen, and welcome to the third quarter 2008 earnings call. At this time all, participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.
I'll now turn the call over to Ms. Laura Gagnon. Ms. Gagnon, you may begin.
Thank you. Welcome to the Ameriprise Financial third quarter earnings call. With me on the call today are Jim Cracchiolo, Chairman and CEO, and Walter Berman, Chief Financial Officer. After their remarks we would be happy to you’re your questions.
During the call you may hear references to various non-GAAP financial measures which we believe provide insight to the underlying performance of the company's operations, reconciliations to the non-GAAP numbers to respective GAAP numbers can be found in today's material available on our Web site.
Some of the statements that we make on this call may be forward-looking statements reflecting management's expectations about future events, operating plans and performance. These forward-looking statements speak only as of today's date and involve a number of risks and uncertainties. A sample list of factors and risks that could cause actual results to be materially different from forward-looking statements can be found in today's earnings release, our 2007 annual report to shareholders, and our 2007, 10K report. We undertake no obligation to update publicly or revise these forward-looking statements.
With that, I'd like to turn the call over to Jim.
Thank you. Good afternoon everyone. Thanks for joining us to discuss our third quarter results. I'm going to give you an overview of the quarter and where we stand and then Walter will take you through a fair amount of detail of our results and our balance sheet.
I don't have to tell you that we're operating in an extremely difficult environment. In fact, this is what out question the most challenging time I've seen for the markets in nearly three decades in the industry. We reached the point when no one is immune to such extraordinary dislocation. The markets clearly impacted us. The 24% year-over-year decline in the S&P 500 through September 30th took a toll on our asset levels and our fees and clearly things have only intensified in October as the S&P is down 20% just this month and is now down 37% for the year.
Despite the market affects, our business remains sound, because our model is built around long-term financial planning; our clients are staying the course. Client retention is at a very solid 94%. At the same time, our advisors are working to ease client anxiety over the markets and the reserve fund issue which I'll address shortly.
Still with the strong support we provide, advisor satisfaction remains high and our franchisee advisor retention is over 93%. In fact, among almost experienced franchisees retention is at an all-time high of 96%.
We're able to weather these times because of decisions we've made and because of strong operating platform we built over the three years since our spin-off. Our enterprise risk management continues to serve us well. We have a high quality investment portfolio as well as strong liquidity and excess capital. I should note that in order to maximize our liquidity in these highly uncertain markets we're (inaudible) share repurchase program.
We're also managing our expenses aggressively and in fact we are escalating our expense initiatives. And we have the right business model and the right leadership in place to navigate tough times. The decisions we're making now, as well as our overall positioning will make us stronger when the markets and the economy emerge from this difficult period.
Now I'll give you some additional context for our third quarter results. We reported a net loss of $0.32 per share which was driven by several significant market impacts that I'll describe shortly. Excluding these impacts, our core operating earnings of $1.04 per share were also significantly affected by the equity market depreciation including its impact on DAC mean reversion. This was partially offset by DAC unlocking and continued tax benefits. To be clear, we consider these items part of our core operating earnings.
If we exclude the credit market impacts, net revenues were down 6% compared to a year-ago, primarily due to the equity market impacts on asset net balances and lower levels of client activity. Meanwhile, our core general and administrative expenses were down 6%. Our return on equity, excluding the extraordinary credit market losses realized gains and losses and separation costs was 12.5%.
As we told you since the outset of the credit crisis, our balance sheet is strong. But it's not immune to the credit market deterioration since last September. As we disclosed a few weeks ago we were affected in several ways by Lehman Brothers bankruptcy as well as by the WaMu failure. Despite our relatively limited holdings in nonagency residential mortgage-backed securities severe deterioration in the real estate market also affected us. All told, we reported $213 million in after-tax credit related losses.
The Lehman Brothers bankruptcy impacted our RiverSource and money market funds which held Lehman paper. It's important to remember that Lehman held a commercial paper rating of A1/P1 at the close of business on Friday, September 12th. Before the markets opened again, Lehman had declared bankruptcy, never before had a major corporation gone from A1/P1 straight to default. The default led us to provide capital to our money market funds in order to maintain their NAV at a dollar.
As I'm sure, you all know, the reserve primary fund did not maintain its $1 NAV following the Lehman falling and the reserve subsequently stopped redemptions from all of its funds. Our clients had significant assets in both the primary and the government fund and all those funds are still frozen more than 40 days later.
Let me tell you how this has affected us. Because of our strong liquidity position, we've been one of the few affected firms able to provide clients with the interim cash they need to pay their routine expenses. Of course, this comes at a cost to us, we're not recouping our cost to funds, but importantly, we're not jeopardizing the company's liquidity by the strength we have in helping clients through this difficult period.
We have also made the decision to mitigate our clients' losses in the primary fund. We took this step because of the extraordinary nature of the event. This reimbursement will be distributed to clients when the primary fund completes its liquidation and distributions, but we've recognized the $23 million after-tax liability now. Our results also include an $8 million after-tax provision for losses on reserve related receivables.
We have engaged in extensive outreach to regulators and legislators seeking their help and influence with the reserve situation. We're disappointed with the lack of action and we're fighting as hard as possible for a fair and reasonable resolution to the situation.
Now that we've addressed the extraordinary events, let me move on to discuss some of the trends we're seeing in the business. Like most investors, our clients are worried about what will happen next. As a result, in many cases, they're frozen. They don't want to take action in these market conditions; however they're maintaining their long-term focus and they're working closely with their advisors.
Our client relationships endure over time even in such difficult markets. As evidenced, our branded financial plan net cash sales were up 9% over a year-ago, with sequential declines reflecting a seasonality impact as the third quarter's often our slowest quarter.
In the advisor force, we're pleased with our strong retention and satisfaction given many stresses the advisors are facing right now. The number of advisors in the employee channel continues to decline although at a slower pace than earlier this year as we continue to re-engineer our employee channel.
Keep in mind, we will see an increase of about 950 employee visors when we close the acquisition of H&R Block financial in November. That closing is on track and we'll continue to feel good about this transaction as the opportunities it presents both to H&R Block and Ameriprise advisors as we move forward. In addition to the 950 new employee advisors, we expect the transaction to add $27.5 billion in assets.
Now I'll move onto the product areas. Owned, managed and administered assets declined 20% compared to a year-ago, primarily, due to market depreciation. We also experienced out flows in both RiverSource and Threadneedle.
In general, clients are buying fewer variable products like Wrap, mutual funds and variable annuities and opt-ins for fixed products like certificates and fixed annuities. In Wrap accounts, we partially offset market impacts on assets with net inflows. However, inflows slowed to $657 million during the quarter.
Overall, RiverSource fund flows were negative $1.4 billion primarily due to lower sales as clients resisted putting money to work in equity funds. Redemptions were stable however.
Investment performance continues to be a factor in our net flows. Our three and five year performance remains solid in many categories, and we have pockets of real strength this year particular in our Minneapolis office. But our other one and two year performance numbers have been weaker.
We've addressed a key area of underperformance by parting ways with managers of some of our large underperforming funds at our Boston office. We're in the process of moving these assets to other better performing funds, including some Seligman funds after we close our acquisition next month.
The Seligman acquisition gives us exciting opportunities. The transaction we had $16 billion of assets including $3 billion of hedge fund assets. Seligman will bring us world-class technology and value teams as well as significantly enhance our third-party distribution opportunities.
Threadneedle's investment performance remains competitive. Outflows at Threadneedle have resulted from both the continued outflows of Zurich funds and hedge fund redemptions as well as from the overall pull back from equities in the European marketplace. Threadneedle is also taking action to adjust its expenses to the current revenue environment.
In other product areas, net inflows and variable annuities slowed to $568 million while net outflows of $184 million and fixed annuities improved by 75% over a year ago. Sales of variable annuities have slowed across the industry as clients remaining cash and other liquid positions which in turn has benefited our sales of certificates. Sales of certificates were up 47% sequentially.
In the insurance business, life insurance (inaudible) up 4% over a year-ago to $192 billion despite a slow growth market. Auto and home policies increased by 5%. Total protection segment premiums were up 4% compared to last year.
To summarize, this was clearly a very difficult quarter for the entire industry and we were no exception. We're in the midst of a historic dislocation across the capital markets and we're a market sensitive company. Down markets affect our fees, spreads and asset levels and we obviously expect this to continue given the market conditions thus far in the fourth quarter.
So to weather this storm we're scaling back our investments in a number of areas and we're cutting expenses aggressively. In fact, we expect to drive general and administrative expenses down further in 2009. But I want you to understand that we remain 100% committed to our strategy because we demonstrated that it works.
We're very confident that we have the ability to rebound and return to strong performance when markets stabilize. Let me tell you why. While market environment can continue to impact our asset portfolio, our balance sheet remains strong. We continue to maintain significant excess capital and we're very good in a very sound liquidity position. As a result we'll not have to repair major problems caused by poor decision making
Just as important our model is built around long-term relationships and those relationships are enduring through this period. And our model provides a diversified set of revenues and income streams. So overall the economic and market environment remains very tough, but we continue to feel good about our financial position and our compelling long-term opportunity.
Now I'll turn it over to Walter for more details on our balance sheet. After that, we'll take your questions. Walter?
Thanks, Jim. In my remarks I'm going to provide more insight into three critical areas. First, our financial and operational results for the quarter, next, the drivers are our financial position and balance sheet strength, and lastly, going forward implications of the current environment.
First let's take a look at the quarter. Our net loss of $0.32 per share was driven by the credit market dislocation we experienced in September and the resulting high level of impairments. As Jim told you, in September, we saw the overnight bankruptcies of Lehman Brothers and the takeover of Washington Mutual. These events combined with others significantly impacted liquidity and spreads across the market.
As relates to our residential mortgage backed security impairments, we recorded $66 million in after-tax losses which reflected market conditions. We have now impaired all of the AAA-rated mezzanine tranches of our all-day securities backed by option arms.
We continue to hold approximately $400 million in non-impaired Super-senior all day securities backed by optional arms, but they're all in the most senior positions in the structures, some with more than 50% subordination.
In the quarter, our core operating earnings were $1.04 per share. As Jim indicated earlier, these core results reflected continued strong client and advisor retention. Core operating revenues and earnings included several negative market impacts to only slightly more than $75 million after-tax.
First, lower equity markets affected our fee revenue. Second, we have lower net investment income because of the higher levels of liquidity we've chosen to build in this environment and lower fixed annuity balances. Finally, we experienced a mix shift driven by increased risk diversion among our clients which has resulted in lower traditional sales and lower distribution fees.
Offsetting these negatives were three positives, which are detailed in our release. First, $40 million net after-tax benefit from items related to valuation of DAC and other balances for RiverSource Life products. These include $69 million of benefits from our annual review and a locking of long-term valuation assumptions and from the implementation of a new valuation system. Those benefits were partially offset by mean reversion which was a $29 million after-tax loss for the quarter.
Next, a $9 million benefit from ineffectiveness in our Living Benefit Hedge Program. While the impact of widening spreads was a positive, this was significantly offset by separate account, underperformance compared to the industries we used to hedge those accounts or basis risk. This basis risk has a bigger impact to hedge effectiveness when client guarantees are in the money.
Our models assume that clients will behave rationally and therefore be less likely to let contracts lapse. Excluding the impact of wider spreads, we believe a loss of $22 million is representative of our hedge ineffectiveness. Finally, as in most quarters, we continue to have after-tax benefit of $14 million. As Jim said, another positive in our strong control over G&A expenses. Core G&A expenses were down 6% year-over-year and 8% year-to-date.
So in summing up our financial and operational results for the quarter, the $0.32 loss was driven by dislocation in the credit markets, the $1.04 core earnings was impacted by $0.34 per share negative market effects and offset by $0.28 per share in positive I just described.
The second topic to address is our financial strength. Our earnings are supported by financial strength that we've created over the past few years. Liquidity, capital position, and asset quality.
Despite the impairments we took in the quarter, our assets are well-positioned to deal with the current environment. At Ameriprise, we've always had a strong risk management culture and risk reward decision process, a long standing product approach towards incorporating risk and return into our decisions.
Let's first look at liquidity. We have over $4 billion in cash and equivalents with $1.3 billion at the holding company. We expect to maintain conservative levels of liquidity in this environment. Ending the year with over $1 billion at the holding company, after using approximately $800 million for the two acquisitions we announced earlier this year.
We believe we have more than adequate and stable sources of liquidity for our future needs as we do not have a security lending program, don't rely on bank loans, debts [ph] or other short-term institutional finance. We have no – our debt is stated to – slated to mature in late 2010 and continue – and we continue to retain lines of credit at the parent subsidiary and mutual fund levels.
Second, our capital position, we continue to maintain substantial excess capital and expect to end the year with approximately $1 billion in excess capital.
On our Web site, you'll find significant enhanced disclosures for our entire own asset portfolio. We have a portfolio that remains high quality, well-diversified and well-positioned to weather the economic cycle. I would encourage you to review the detail and make the comparisons. I believe you'll see why we feel good about our position.
Over the past several years, we have been quite measured in taking our credit risk and we believe the reward wasn't sufficient. Therefore, we avoided credit default swaps or other structured credit exposures in bond portfolio, private equity, hybrids, and have limited exposure to CLOs, equities, trading securities and hedge funds, totaling just over 1% of our investment portfolio and almost entirely due to seed money for new investment products.
While unrealized losses have increased in the portfolio, they are generally the result of spread widening across all fixed income asset classes. Year-to-date, our realized losses relative to our portfolios are some of the lowest across the industry. And our unrealized losses at $986 million after-tax are in line with the industry. We do not believe we realized these – we will realize these losses and we have ample liquidity to hold to maturity.
Corporate spreads have reached 20 plus year high. And we believe this sector will be the next area of heightened attention for the market given concerns about the economic weakness. Ultimately, we expect to continue to also move to CMBS sector and whole loan commercial mortgages.
So let me touch on each of our portfolios in these areas. Our investment grade corporate bond portfolio experienced the biggest increase in unrealized losses contributing almost 80% of the increase in unrealized losses in the quarter. Even so, the price decline experienced by our portfolio was only 4%, compared to the 7.5% among the Lehman corporate index.
In our corporate bond portfolio, you'll see a preference for credits and industries regulatory oversight and a bias towards asset rich companies with strong cash flow generating capabilities across multiple economic cycles.
With our BBB-rated exposure, 65% is in telecommunication, electric utilities, consumer noncyclicals and energy industries all regulated asset rich are noncyclical. In our CMBS portfolio, the change in unrealized loss was less than 2% of book value. This portfolio is very high quality and well-diversified. It's 100% AAA and contains 37% agency paper. And it's almost entirely, in 2005, early advantageous. Reflecting our decision in late 2006 to avoid markets when underwriting standards for securitizations were deteriorating.
In our commercial mortgage whole loan portfolio, we continue to have low LTVs, high cash flow coverage and no delinquencies. It is well-diversified both from a geographic and property type.
Lastly, I want to address the implications of the current market for ongoing performance. Since the end of the third quarter, the equity markets are down another 20%. Lower equity markets in the future will naturally impact our asset levels and revenue. In addition we would accelerate the write-off of our DAC balances as most of you know we adjust DAC balances on a quarterly basis.
In terms of our two acquisitions, based upon current markets and what we know today, we continue to expect Seligman to be accretive in 2009 and H&R Block Financial advisors to be accretive in early 2010. If current markets persist, 2009 will be challenging. Therefore, we are aggressively stepping up our re-engineering. Though we'll continue to reinvest in the business, we'll bring more of these savings to the bottom-line as you've already seen so far this year.
We expect to continue to hold excess capital at the end of 2009 well in excess of a billion dollars. Current equity market levels, statutory reserve will certainly be increased for variable annuities and we may be required to hold more capital to comply with C-3 Phase II. And analysis we run to determine regulatory capital requirements with variable annuities products. Even with these additional requirements, we believe that RiverSource, RiverSource Life's LBC ratios – RBC ratios, excuse me, will remain above levels appropriate to maintain AA ratings.
So let me wrap up my remarks before the Q&A. Clearly, the credit market dislocation and overall environment affected our financial and operational results for the quarter. But our business and balance sheet fundamentals remain strong. In both the near and long-term, we believe our strong financial foundation and business model will allow us to continue to execute against our stated strategic objectives.
With that, I'll turn it to Jim and we'll take questions.
Okay, we're ready to take Q&A, operator.
(Operator instructions) Our first question comes from Suneet Kamath. Please go ahead.
Suneet Kamath – Sanford C. Bernstein
Thank you very much. Just a couple questions on capital. Walter, you had said that your risk-based capital ratio I guess at the end of '08 will be above what you need for AA rating. I think end of last year it was well above that, close to 700%. Can you give us any sense – I know some companies have been given a sense of approximately where that would be as of third quarter-end. Can you give us a sense of that? And then sort of related, in terms of stopping the buy back program, obviously, you've done a couple acquisitions, should we assume really other than the dividend, no capital redeployment going forward, including – inclusive of acquisitions and then related, what should we be looking at? Is it the credit markets? Or the equity markets? What will give us a sign of when you might get back into the market to buy your own stock considering the valuation right now? Thanks.
Okay. As you know, the RBC calculation is well – you can do it at the end of the third quarter. You still have to run through your tests for your C3 Phase II. We've preliminary run it and it's in excess of 450, but again, that's a preliminary run before we complete the C3 Phase II. It was at 700 and we have declared dividends which we moved to the parent and which we've discussed in previous calls. As it relates to the question about resuming, at this particular stage, based upon the credit and liquidity, we really don't see us getting back until we see improvement in those markets and on that basis, we just going to hold off how to drive until we feel comfortable from that standpoint. We do have excess liquidity as we talked about and excess capital position. As far as acquisitions, interesting times right now, we want to make sure that we're protecting what we have and we'll have to be in a very exceptional situation.
We still feel we're in a very good position. I know many of you have questioned and think about the asset-owned portfolios of many companies. So we want to be very clear that we feel we're in a good position, we don't need equity, we don't need to go out for financing. We have a strong position of excess capital, and we'll just look and monitor the markets and when things start to ease up and people feel more comfortable, then we'll have degrees of freedom again.
(Operator instructions) We have no further questions.
This is Laura Gagnon. We'll be in my office available for your questions later on this evening. That number is 612-671-2080. Thank you, operator.
Thank you, everyone.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.
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