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The Phoenix Companies, Inc. (NYSE:PNX)

Q1 2009 Earnings Call Transcript

May 5, 2009 11:00 am ET

Executives

Naomi Kleinman – VP, IR

Jim Wehr – President and CEO

Peter Hofmann – Senior VP and CFO

Chris Wilkos – EVP and Chief Investment Officer

Analysts

Bob Glasspiegel – Langen McAlenney

Steven Schwartz – Raymond James

Craig Carlossi [ph] – Mass Capital

Operator

Good morning and welcome to the Phoenix First Quarter 2009 Earnings Conference Call. Thank you for standing by. All participants will be in a listen-only mode until the question-and-answer session. (Operator instructions). Today’s call is being recorded. If you have any objection, you may disconnect at this time.

I will now turn the call over to the Head of Phoenix Investors Relations, Ms. Naomi Kleinman. Thank you, ma’am, you may begin.

Naomi Kleinman

Good morning and thank you for joining us. I am going to start with the required disclosures and then turn it over to Jim Wehr, our President and CEO, for an overview of the quarter.

With us today are Peter Hofmann, Chief Financial Officer; Phil Polkinghorn, Senior Executive VP for Life and Annuity; Chris Wilkos, Chief Investment Officer; and Dave Pellerin, Chief Accounting Officer. Our first quarter earnings release, our quarterly financial supplement, and the first quarter earnings review presentation are available on our website at www.phoenixwm.com.

Slide two of the presentation contains the important disclosures. We may make forward-looking statements on this call that are subject to certain risks and uncertainties. These risks and uncertainties are discussed in detail in our first quarter earnings release and our latest SEC filings.

Our actual results may differ materially from such forward-looking statements. In addition to Generally Accepted Accounting Principles, we use non-GAAP financial measures to evaluate our financial results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our press release and financial supplement.

Now, I will turn the call over to Jim.

Jim Wehr

Good morning and thank you for joining us for our report on first quarter results. Let me start by welcoming two new participants to the call. Naomi Kleinman is Vice President of Investor Relations. Naomi has served in several important financial positions over a 12-year career at Phoenix. Chris Wilkos has just been promoted to Executive Vice President and Chief Investment Officer. Chris and I have worked closely, managing our investment portfolio for more than ten years.

On today’s call, I will summarize the quarter and give my perspective. Peter will give more details around the financials and then Chris will walk through the details of the investment portfolio. We will take questions at the end.

I want to begin with a statement on what I will be focused on as Chief Executive Officer and that is enhancing shareholder value and delivering financial security to our policyholders. Clearly, Phoenix has disappointed investors with our financial performance and declining share price.

I’m keenly aware of investor frustration and I share that frustration. As an investment professional for 25 plus years, I understand the qualities investors look for including producing earnings consistently and keeping the balance sheet strong. I am committed to both.

We must also pursue a realistic strategy to grow the business with an awareness of both the current environment and our ratings. I would do my best not to overpromise and to improve our operating performance so we can deliver results and rebuild the confidence in Phoenix and its management team.

Let me turn to the first quarter and I will start with a summary of the key business drivers. Mortality remained consistent with our expectations. Surrenders rose, but were well within manageable levels. Sales were lower as a result of a number of our distributors stopping selling Phoenix products due to our recent rating downgrades and major expense initiatives have not yet delivered financial benefits in this quarter, but will by the fourth quarter of the year.

Overall, our business fundamentals remain solid including mortality and surrenders. Surrenders were elevated, but still manageable. We believe the rise reflects a combination of consumer anxiety and personal needs for cash, as well as concerns about our recent rating downgrades. We are actively managing them through enhanced outreach to producers and policyholders and by maintaining a higher level of cash and liquid assets.

The slowdown in our sales reflects some of these factors and we’ve also seen a general industry slump as consumers remain cautious about the economy and making new investments in financial products.

We expect sales levels to remain depressed for the foreseeable future. As you may recall, our two major distributors, State Farm and National Life Group, stopped selling in early March. So, the first quarter does not include the full impact of those actions.

On the expense front, we are making progress toward our previously announced goal of $65 million in annual savings. We made the decision in the quarter to eliminate at least 25% of our workforce so that our infrastructure matches our business volume and evolving business model.

We announced 170 position eliminations in late April along with our intention to complete our downsizing by the end of the second quarter. Once severance costs of approximately $15 million have been incurred, we expect the expense reductions to fully materialize by the fourth quarter.

I would also like to point to the key factors affecting our investment portfolio. Investment income stabilized, but continued to be affected by alternative investments. Unrealized losses improved from the fourth quarter. Impairments also declined from the fourth quarter and ratings migration and other performance metrics continue to hold up well relative to the market.

The financial markets continue to have an adverse impact on our investment performance with net income still depressed, although on the open block it increased modestly from the prior quarter. Alternative asset returns from venture capital, hedge funds, and mezzanines were the major drivers of the portfolio’s overall performance. This reflects not only the environment, but also the delay in partnership reporting, which can lag one to two quarters.

Our unrealized loss position improved from year-end and impairments moderated compared to the last two quarters. We are seeing clear signs of improved liquidity in the bond market and our portfolio.

Finally, let me comment on how these investment results translated to our balance sheet. It remained healthy and is one of our priorities, although there were differences between GAAP equity and statutory surplus. Our GAAP equity benefitted from the improvement in unrealized losses and the deconsolidation of two CDOs.

Our statutory surplus was negatively affected by impairments and losses in alternative investment classes, as well as by the impact of financial markets on annuity earnings and reserves. These factors, along with significant rating downgrades of bonds held in the investment portfolio, brought our estimated RBC to 275%. Absent the bond downgrades, RBC would have been above 300%.

We remain adequately capitalized and liquid and are looking at a combination of risk reduction, reinsurance, and other approaches to enhance our regulatory capital position. I’ll leave it to Peter and Chris to provide additional detail around the financials and investment portfolio.

I would like to spend my remaining time talking about our four strategic pillars. They are as follows. Number one is our commitment to a healthy balance sheet. Number two, our commitment to policyholder security. Number three is the commitment to reducing expenses. And four is the commitment to a sustainable growth strategy. These pillars are the essential action areas that will bring about a better future for Phoenix, its investors, and policyholders.

I’ll start with the first one, a healthy balance sheet. A strong balance sheet is core to the financial strength and flexibility of any company. I’m pleased to say that ours is in good shape and we continue to take whatever actions necessary to ensure that it stays that way. Over the last several months, we have substantially increased our liquidity position and maintain a low debt-to-capital ratio. I would remind you we have no debt maturing until 2032.

We recently announced that we would suspend our dividend to shareholders for 2009 to preserve capital. We also withdrew our application to participate in TARP after our acquisition target was seized by the FDIC.

Our second commitment centers on policyholder security, which starts with our products. Our products provide significant value and security to our customers at a time when they typically need it most. Policyholder security also means ensuring that our obligations are honored fully.

We are very focused on communicating with both policyholders and their advisers about our ability to pay claims. This last point is particularly important in this anxious environment when customers are uncertain about what they should do with their policies. Without the facts, emotion can take over, leading to a decision based on fear rather than facts.

Now, I’ll turn to our commitment to reducing expenses, which include more than just headcount reductions. It also focuses on operational efficiencies to improve the customer experience. We will continue to use lean management principles to streamline processes we use every day and raise our level of scrutiny of initiatives to ensure that we focus first on ones that will have the greatest impact on our business.

We are also looking closely at will it make sense to do in-house or what could be done equally well or better by others outside the company and at a lower variable cost. In addition, compensation programs are being reviewed and I want to spend a minute on that.

My commitment to investors is to design a structure that is in keeping with our smaller size and new business model and also reflects the times we are operating in. We will be evaluating everything including senior management compensation and changes will be meaningful.

We have already frozen salary level this year for the 130 most senior employees in the company and our new incentive plan for 2009 reinforces our sharp focus on maintaining our financial strength, preserving shareholder value, and reducing expenses. We have lowered the threshold and target payouts by 30% and reduced the maximum payout from 200% to 150%. The Board has also approved a 30% reduction in its annual retainer fee for the remainder of 2009.

Now, let me turn to our strategy for future growth. This element of our strategy is less certain and still evolving. I believe it’s important to state that we are going to be very realistic about our alternatives. In this environment and with our current ratings, it will be unproductive to continue down the same path as before.

We have determined that we need to pursue paths that complement and leverage our strengths. These include our record of product innovation, our underwriting capability, our partnering skills, and our professional wholesalers. Out of this assessment, we have developed a three-pronged strategy, private label, core products in existing and new distribution channels, and alternative retirement solutions.

Private label is not a new concept that has proven successful in a number of industries. We believe we can use our insurance skills to do the same. We believe our proposition is attractive for companies that want to fill product gaps, but don’t have the time, skills, or resources to build the capabilities on their own.

We have reopened the dialog with companies we had talked to before about distribution relationships who had liked what we offered, but did not want to sell another company’s brand. Our approach allows these companies to get products their customers want cost-effectively and to market them under their own label.

The second prong of our strategy, focused on selling our core life and annuity products within existing distribution relationships and also through new channels such as fee-based advisors and independent marketing organizations. We believe our product innovation and value-added services will allow us to be successful.

The third prong is alternative retirement solutions, which essentially extends features designed for life insurance and annuities to other financial products. Our partnership skills would be important in this approach as well, which also contemplates non-traditional distribution channels.

We are well along with our longevity product development. This product will help individuals to have enough money to live well even if they live for a very long time. Retirement issue should return to prominence once the environment stabilizes. We believe our new strategy will begin to yield results in 2010.

I will leave it there and simply add that I plan to reach out actively to the investor community. Let me end by reiterating that our management team is dedicated to enhancing shareholder value and delivering financial security to policyholders.

With that, I will turn it over to Peter and Chris. We will have Q&A at the end. Peter?

Peter Hofmann

Thank you, Jim. If I could ask you to turn to slide 6, which shows financial highlights for the first quarter. You’ll see we had a net loss of $74.8 million or $0.65 a share and an operating loss of $117.8 million or $1.02 per share. Both were overwhelmingly driven by a $115.9 million increase in the valuation allowance against our deferred tax assets. This non-cash charge was the equivalent of $1 per share.

The valuation allowance increase was necessary for GAAP accounting purposes. Economically, the related tax benefits expire between 2011 and 2028 and we certainly believe that they represent ongoing value to shareholders. The net loss was smaller than the operating loss, because we recorded a gain on deconsolidating two CDOs that were previously consolidated on our balance sheet, essentially reversing non-economic losses that we had been reporting over the last several years.

Core operations were adversely affected by issues related to the past, the present, and the future. The past, because net investment income continued to be affected by the 2008 market meltdown as year-end results reported by private equity and mezzanine partnerships flowed through the results. The losses related to these investments totaled about $0.04 per share in the quarter.

The present, because the 12% decline in the S&P 500 accelerated DAC amortization, required higher annuity reserves, and reduced fees for a combined impact of about $0.03 per share. And the future, because as we transition to a lower cost structure, we incurred severance costs and carried non-deferred sales related expenses that will be eliminated over the course of the year. Taken together, these accounted for about $0.08 per share.

And beyond these items, mortality was broadly in line with expectations and surrenders increased, although not alarmingly so. Life and annuity sales declined 53% and 20% from the fourth quarter respectively.

You can see the impact of these various items on slide 7. Revenues in the closed block – revenues in the open block remained low due to weak net investment income, while expenses and DAC amortization were higher as a result of the factors I just mentioned.

The regulatory closed block contribution remains very stable and consistent with the glide path toward the block, but recall that this does not include any operating expenses because the block did not fund operating expenses. So, a comparison of closed block pretax income and open block pretax income is not meaningful.

The effect of tax rate excluding the valuation allowance increase reflects the benefit of permanent differences. The rate is high because we did not use an estimated full-year tax rate. I’ll review the details on the realized gain a bit later.

Slide 8 shows a five-quarter trend for investment income outside the closed block, which is the component that affects reported earnings. Though the trend has stabilized, we do expect some additional negative results attributable to year-end partnership statements to emerge in the second quarter.

Slide 9 details expenses for the past five quarters. One-time expenses include items such as severance, proxy and spin-off expenses. Excluding these items and excluding incentives and the non-deferred sales related expenses, core expenses are down $3.5 million from a year ago and up by about $4 million in the first quarter. The increase is – from the prior year, from the fourth quarter, is partially due to higher pension costs. Clearly, we expect this quarterly run rate to decrease as we realize the impact of our expense reductions.

Turning to mortality results on slide 10, margins in our core UL and VUL blocks were broadly in line with expectations. With business volumes declining, we do expect mortality margins to decline somewhat over time. However, in the near term, our expectation remains approximately 50% in universal life and 60% in variable universal life. Mortality in our older blocks of business was also within expectations, albeit somewhat less favorable than in the last several quarters.

Given our situation, as well as the environment, we are closely watching persistency. We will report more detail as part of our communication with investors. To give an overall trend, on slide 11 we provide annualized aggregate surrender rates based on fund value surrendered.

You can see that life surrenders have increased over the past two quarters, but remain at manageable levels. Annuity surrenders are more volatile, partially because we include our discontinued product blocks, as well as private placement contract at Philadelphia for National Group in this measure.

There are three points I would make with respect to these statistics. First, they are aggregate statistics. Experience differs significantly by block of business and not all surrenders are created equal from a profitability perspective. Second, these numbers do not represent cash out the door because in many cases, there are loans outstanding against the policies and surrender charges due upon surrender.

And third, we believe the increase in surrenders is part of an industry trend and a symptom of general liquidity needs among consumers. A recent survey by a trade organization indicated that surrender rates have increased at about a third of the companies surveyed.

Turning to sales and beginning with life insurance on slide 12, they were down substantially following the suspension at some of our key distribution relationships. In addition to cases that were already in the pipeline, we continue to have a modest level of sales through independent channels, but we would expect the numbers to decline further in the second quarter.

The story is similar in annuities on slide 13. The number of cases that were in the pipeline in the quarter contributed to total deposits of $98 million in the quarter. Here as well, we expect a weak second quarter. We have not built aggressive assumptions about private label sales into our sales projections, in fact none until 2010. The focus on less rating-sensitive segments should begin to make a modest contribution in the second half of 2009.

Let’s move to realized losses on slide 14. Chris will cover the impairment, so let me comment on the other areas. First, we adopted the accounting guidelines for fair value measurement and other than temporary impairments early, separating the credit and non-credit components of impairments. The non-credit component of the impairments was $19 million and recorded directly to shareholders’ equity.

Second, you can see the impact of the $57 million related to the deconsolidation of CDOs following the spin-off of Virtus. These are losses that had been recorded in our net income, but are0020ultimately borne by the CDO note-holders, not Phoenix. They were reversed upon deconsolidation.

Finally, the transaction gain line includes $13.1 million related to the effect of Phoenix’s credit on our annuity living benefit liability. Overall, our hedge gain including this impact was $6.4 million.

Statutory results are summarized on slide 15. Surplus for Phoenix Life decreased $144 million, primarily as a result of credit impairments, higher annuity reserves, and negative alternative asset returns. Each case, these have the potential to reverse at least partially. Annuity reserves are directly correlated with the equity market and would be lower today, given the April market.

Impairments reflect marks to fair value rather than that realizable value of the securities. In the current environment, this difference can be meaningful. And alternative asset returns include a large unrealized component, reflecting year-end marks by partnerships, which do have some potential to recover.

RBC for Phoenix Life decreased to an estimated 275% and the statutory gain from operations for Phoenix Life was $12 million, implying an equal amount of potential dividend capacity thus far in 2010. Slide 16 shows the major components of the decline in our estimated RBC ratio. Note that approximately half the decline is due to rating downgrades in the bond portfolio and approximately half due to the surplus changes that I described a moment ago.

The downgrades were driven in large part by a re-rating of the structured security market at Moody’s. While an RBC of 275% is not inconsistent with our current ratings and certainly represents solid capitalization, our objective for capital management purposes will be to offset further declines and if possible, at acceptable cost improve it to 300% or more over a reasonable period.

Our main focus to achieve this will be on one, presuming reinsurance options; two, optimizing internal capital management; and three, reducing risk. On that front, we will seek to reduce the capital requirements related to the low-investment grade securities, similar to the steps we took in the fourth quarter when we sold equities.

With that, let me turn it over to Chris for a discussion of the investment portfolio.

Chris Wilkos

Thank you, Peter. I plan to cover four topics on this morning’s call. The first is an attribution of our investment income results for the quarter. The second is a review of our first quarter credit impairments and trends in the level of unrealized portfolio losses. The third is an analysis of our portfolio quality and liquidity, and finally, a detailed review of our residential and commercial mortgage-backed securities holdings.

Let’s start with net investment income on slide 17. Net investment income declined by $17.8 million from the fourth quarter of 2008 to the first quarter of 2009. The average yield on the portfolio was 5.6% for the first quarter. A significant component of the decline resulted from losses in our venture capital and other invested asset segments, which comprised 5% of our overall portfolio.

Like all investors in alternative asset classes, we have seen a reduction in income and often loss from private equity, mezzanine funds, hedge funds, and other partnership assets given the significant declines in markets and economic weakness.

Phoenix has a long and successful track record in venture capital and long-term returns have averaged in the upper-teens. Almost all of our venture capital holdings are in the closed block, which has benefitted from those long-term returns. Open block investment income was less impacted by alternative investment returns and increased slightly sequentially from last quarter. Core bond income improved in both the open and closed blocks.

Slide 18 shows first quarter credit impairments by sector compared to our fourth quarter results. Credit impairments declined sharply from the brutal results of the first quarter, dropping to $38.3 million. The majority of those impairments came from debt holdings with some partnership write-downs.

In the fixed income portfolio, corporate bonds accounted for 62% of impairments while mortgage securities comprised of prime, Alt-A, and subprime, accounted for 17% of impairments. The balance came from collateralized loan obligations and other asset-backed securities.

Slide 19 illustrates that credit market performance has begun to improve as credit risk premiums declined during the first quarter and continued to decline through the end of April. Unprecedented credit spread widening occurred during 2008 and all credit sectors were adversely impacted as unrealized losses increased sharply.

Credit spreads for the four key sectors of our portfolio shown on this slide improved modestly during the first quarter and have had a more significant improvement in April. We believe this indicates a thawing of the frozen credit markets, the impact of government programs to boost liquidity, and a change in buyer perceptions of the high-risk premiums that are available in today’s markets.

Slide 17 shows our portfolio had a modest decrease in unrealized losses during the first quarter, consistent with the improvement in spreads shown on the previous slide. Unrealized losses declined by about $70 million. Some of the improvement was also attributable to the adoption of FSP FAS 157-4 during the quarter, which allows the company to estimate fair value for assets where the volume and level of market activity have significantly decreased.

70% of the unrealized losses in our portfolio are attributable to investment-grade securities, which have extremely low historical default rates. Given the strong performance of the credit markets in April, we would expect our unrealized loss position to further improve since quarter-end.

Turning to slide 21, Peter has shown you the impact of credit rating downgrades in our portfolio and its resultant impact on risk-based capital. During the first quarter, there were significant rating downgrades in the market, in particular in the structured bonds sector.

Structured bonds consist of mortgage-backed, asset-backed, and CDO sectors and during the quarter, 20% of this category was downgraded from investment grade to below investment grade. Sweeping changes in rating methodologies drove this significant increase in Fallen Angels.

The Phoenix portfolio experienced less than half the market downgrades in our structured portfolio and about half of the market downgrades in our public corporate bond portfolio. We were most impacted by downgrades in the collateralized loan obligations sector. There were a large number of downgrades from A-rated and BBB-rated tranches to below investment grade as Moody’s increased projected default loss estimates for bank loans.

Under NAIC rules, we are required to use the lower of two ratings when a security is split-rated. There were also a number of downgrades in bonds backed by bank trust preferred securities where estimates of future losses were revised upward.

On slide 22, the impact of the significant market downgrade activity has been to increase our portfolio’s percentage of below investment grade bonds to 10.2% of total bonds. We have made virtually no new purchases of high-yield bonds in the last 12 months. This result is at the top of our range for below investment grade holdings. The fact that almost 60% of our below investment grade allocation is rated NAIC 3 or BB, should be a positive as historically BB default rates are a fraction of the overall high-yield default rate.

A few points about our below investment grade exposure. As I just mentioned, the NAIC rules require us to use the lower of two ratings when a security is split-rated. Given the changes in rating agency methodology during the quarter and the requirement to use the lower rating, we ended up with 10% in below investment grade securities. In contrast, using the higher rating would drop the percentage to 7.2% of the portfolio, and using just one or the other of the agency’s ratings fall somewhere in between.

My point is not to question the methodologies used, but to illustrate that the percentage of below investment grade bonds is really a range, which depends on which rating is used. In today’s environment of different views among agencies, the point is important in viewing portfolio quality.

My second point is that we do not believe that the majority of these downgrades reflect actual increased economic risk. We purchased the majority of our CLO bonds to withstand breakeven annualized default rates of 7% or higher. Two-thirds of our holdings can withstand a minimum 10% annualized default rate before we lose principal.

We realize that loan defaults have accelerated, but we believe our securities are well protected even in a higher default rate environment. At year-end, only 6.6% of our CLOs had default rates of 3.5% or higher. Given the recent strength in the below investment grade market, we are actively working to reduce our below investment grade holdings. This effort does not include securities where we believe that lower ratings overestimate economic risk and therefore, unduly depress the price.

Slide 23 provides an update on liquidity and our portfolio at quarter-end. For the past 12 months, we have believed that having adequate liquidity was an essential priority. During the past year, we increased the percentage of our investments into extremely liquid market segments. We increased our short-term cash in treasury position and doubled our allocation to agency mortgage-backed securities, which were very high quality and also extremely liquid.

The net effect of our actions has been to nearly double liquidity from a normal 5% allocation to 9.5% at quarter-end. These numbers do not include an incremental $700 million in high-quality agency CMOs in our portfolio. While we may not need this substantial level of liquidity, we feel that it is prudent in the current environment to have an enhanced position.

Slide 24 summarizes our non-agency residential mortgage holdings by borrower type, credit quality, vintage, and collateral type, the factors that drive the ultimate performance of residential mortgage-backed securities. Not much has changed in our mortgage-backed portfolio since year-end. The Phoenix portfolio remains very high quality, seasoned, and has a substantially higher amount of fixed-rate mortgages compared to the market in general. We believe those are the factors that drive relative performance.

Slide 25 shows the delinquencies in the collateral pool, supporting our non-agency RMBS securities. Not surprisingly, given the factors that I covered on the previous slide, our delinquency experience is demonstrably better across all collateral types, particularly Alt-A and subprime.

Slide 26 provides a summary snapshot of our $1 billion CMBS portfolio. 84% is AAA rated and less than 1% is less than BBB rated. Even with substantial rating downgrades in this asset class, the percentage of AAA-rated securities is unchanged from year-end 2008.

We believe the strength of our portfolio results from 88% of the loans being originated in 2005 and earlier. Only 2% of our holdings are in CMBS, CDOs. Finally, we have only $10 million in direct commercial mortgage loans as we exited the direct loan business in the late ‘90s in favor of high-quality CMBS holdings.

Slide 27 provides a further in-depth look at our CMBS portfolio and compares it to the CMBS market as a whole. As you can see, we have a higher level of credit enhancement compared to the market, which reflects our emphasis on super senior and senior tranches.

The CMBS market is approximately $850 billion in size and about two-thirds of the market is backed by interest-only or balloon mortgages, which historically have not performed as well as amortizing mortgages during times of stress. Only 27% of our portfolio is backed by interest-only loans. Finally, reflective of our significant concentration in 2005 and earlier vintage loans, our average loan has over seven years of seasoning, nearly twice the market average.

Now, I’m going to turn it back over to Jim.

Jim Wehr

Very good. We will follow our question-and-answer format of two questions per person at a time. Let’s begin with the first question. Emily?

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions). Sir, our first question comes from Bob Glasspiegel from Langen McAlenney.

Bob Glasspiegel – Langen McAlenney

Good morning. I was wondering if you could give us some color on the closed block. It seems from my perspective, that’s going to be a really important part of the overall company over the several quarters. What’s the persistency of that block and has that changed much in the last couple of quarters?

Jim Wehr

Sure, Bob. The persistency in that block has been sort of in the range – been in the past quarters, but it is elevated over past quarters. I don’t have the precise numbers right in front of me, but the increase is in line with the overall – it’s gone up into sort of the still under 10% range, probably in the 9% range annualized in the first quarter. And prior quarters would range anywhere from high-4s to say 7-ish in prior quarters. So, it’s within a 200 basis points of previous quarter’s highs.

Bob Glasspiegel – Langen McAlenney

Okay. Your plan to rebuild sales is obviously going to take a lot of time and you gave us some broad goals or elements to your strategy that are going to be part of it, but can you give us some examples of the type of distributor that you are looking at that will hook up with Phoenix or stuff that’s in play that –?

Jim Wehr

Yes, without mentioning names, we have been obviously making contacts or so. And we have been contacted independently by some independent marketing organizations who would like to explore doing business with us, would largely be amongst independent producers. So that it’s more independent producers who make their decisions one at a time about this sort of thing as opposed to large firms with a gatekeeper who makes the decision for 3,000, 5,000 advisors all along.

So, we’ve been proactively reaching out to distributors who do business with other companies with lower ratings and some have contacted us.

Bob Glasspiegel – Langen McAlenney

Okay.

Operator

Thank you, sir. Our next question comes from Steven Schwartz from Raymond James.

Steven Schwartz – Raymond James

Hi, good morning everybody. My two relate to State Farm and National Life. Peter, maybe – or Phil, maybe you have any sense, given the timing of when those agreements went into suspension, of how much annuity sales and life sales, those two relationships contributed in the quarter?

Peter Hofmann

They would have contributed a fairly meaningful amount. On the annuity side, where State Farm historically accounted for two-thirds of sales, they continue to sell – or process business that was in the pipeline into March. On the life side, it’s a little less from State Farm and National Life really didn’t do any life. So, that’s purely the State Farm relationship. But there also – there was a pipeline of business that we certainly saw coming through this quarter. We would expect the annuity side in particular to drop quite significantly in the second quarter.

Steven Schwartz – Raymond James

Okay. Fair enough. And then just on the State Farm, you talked about obviously the need to rebuild capital, the potential for reinsurance. I’m wondering if there is some discussion maybe going on with State Farm about State Farm taking that book back. I’ve gotten calls from some of their agents who are a little bit worried that – I tell them I don’t think they need to be, but they are a little bit worried State Farm taking some of that book back. Maybe that could help your capital. Could you discuss that? Is there anything going on there?

Jim Wehr

We have ongoing conversations with State Farm, but at this point it would be inappropriate to share the details of those conversations.

Steven Schwartz – Raymond James

Okay. I’ll get back in line.

Jim Wehr

Very good.

Operator

Thank you. (Operator instructions). Our next question comes from Craig Carlossi [ph] from Mass Capital.

Craig Carlossi – Mass Capital

Yes. Hi, good morning. What was your hold co-cash position at the end of the quarter?

Peter Hofmann

Craig, it’s Peter. We don’t disclose it on a quarterly basis. So, that’s not a number that’s out there.

Craig Carlossi – Mass Capital

Could you tell me – maybe [ph] the dividend to the hold co from the (inaudible) in the quarter?

Peter Hofmann

We didn’t pay a dividend in the first quarter.

Craig Carlossi – Mass Capital

Okay.

Peter Hofmann

We do have under the New York rules the capacity to upstream, based on prior-year gain from operations or (inaudible) lesser prior-year gain from operations or 10% of surplus. And that amount for 2009 would be $53 million.

Craig Carlossi – Mass Capital

$53 million?

Peter Hofmann

But we have not made any – at this point, not made any payments.

Craig Carlossi – Mass Capital

Okay. And given the transition of your business, can you talk a little bit more about April’s performance? Specifically, with respect to any surrenders if materially different from Q1 and downgrades in your investment portfolio?

Jim Wehr

We really can’t report on April activity other than to tell you that we are monitoring surrenders very closely. We, I think, gave a very detailed description of the level of surrender activity we are seeing, characterized it and sized it for you as manageable, and outlined the outreach activities that we’re very focused on. Beyond that, really can’t focus on April activity there and I really would have to make the same comment in terms of downgrades in the portfolio for the quarter.

Peter Hofmann

But broadly in the market, I don’t think we’ve seen the same levels out there.

Chris Wilkos

This is Chris Wilkos. We have not seen the same level of re-rating of asset classes that we saw in the first quarter, which was particularly a heavy time for downgrades. It’s been more – I would say, more normal environment in April.

Craig Carlossi – Mass Capital

Okay. Thank you.

Operator

Thank you. Our next question comes from Bob Glasspiegel from Langen McAlenney.

Bob Glasspiegel – Langen McAlenney

Thank you. Any color on the April portfolio? You hinted that there are some positives, but any quantification on just the marks and what that would do would be appreciated.

Chris Wilkos

This is Chris, Bob. We can’t comment on specific numbers, but clearly the decrease in spreads, the decrease in risk premiums has provided a lift to our valuation of our portfolio. In particular, as you are aware, in the high-yield class it was an outstanding month in April. Corporate bonds also had a good month and if those trends continue, we should continue to see some improvement, but I don’t have a number for you for the end of April.

Bob Glasspiegel – Langen McAlenney

You just don’t have the number or you can’t – you don’t want to give interim results? I wasn’t sure which you were saying.

Chris Wilkos

We don’t want to give interim results.

Bob Glasspiegel – Langen McAlenney

Okay. It just seems like some of your competitors that have capital issues have wanted to brag about it. The read might be that it’s not as good as the market if you are holding back the good information.

Jim Wehr

Bob, I wouldn’t make that assumption. Why don’t we revisit the issue and if it’s appropriate, issue an 8-K?

Bob Glasspiegel – Langen McAlenney

Thank you.

Jim Wehr

Okay.

Bob Glasspiegel – Langen McAlenney

Appreciate it.

Jim Wehr

Yes.

Operator

Thank you. And our next question comes from Steven Schwartz from Raymond James.

Steven Schwartz – Raymond James

Hi again. Yes, what Bob said about other companies giving guidance as to what their portfolios look like at the end of April, that’s absolutely true. Just about everybody has – for what that’s worth. The valuation loss, Peter, do I understand this correctly? This is being recognized because there was – the investments with gains basically have dissipated in this market, so there is basically no guarantee that any losses could be recovered. Would that be accurate?

Peter Hofmann

Not exactly. There is a component of the deferred tax assets that relates to capital losses that we do use as a tax-planning strategy, the unrealized gains, and to the degree that we don’t have that, there is component of the valuation allowance that relates to that.

More globally though, what was driving this is that we – is that GAAP requires us to assess our tax situation based on expected full-year 2009 earnings and that given the results that emerged in the first quarter, including the 12% in the market, our projected taxable income for 2009 declined significantly and resulted in a higher probability of a taxable loss.

And what happens under GAAP is that with that change in outlook, we – the bar was in some sense raised, so the burden of proof to support the DTA was raised. And where we – at year-end, we are relying on long-term projections and tax planning strategies to support the DTA, which is permitted under GAAP. That no longer was an option when we were looking at the 2009 projected results. And so we had to, in essence, put up the allowance for – in particular, non-life related deferred tax assets.

Steven Schwartz – Raymond James

Okay.

Peter Hofmann

Okay. Lengthy explanation, but it’s really a GAAP accounting phenomenon.

Steven Schwartz – Raymond James

No, no, that made sense. Jim, on your discussion of split rating and the need to use the lower rating, it was – it had always been my impression – maybe I was wrong, but it’s always been my impression that you use the SVO rating and it’s when SVO changes that you have to change. Are you – is this a national rule or is this something that particularly pertains to the state of Connecticut?

Jim Wehr

Steven, I’m going to let Chris Wilkos respond to that one.

Chris Wilkos

Yes. Steven, the SVO will, I believe, normally take rating from nationally recognized rating agencies. So, in the case of what I was describing where there is a Moody’s and a Standard & Poor’s rating on a particular tranche of a security, those ratings are normally recognized by the SVO in terms of what the NAIC rating is. And the requirement is when a security has two ratings to take the lower of the two ratings and coming up with the SVO rating.

So, for instance, if a bond is rated investment grade by one agency, below investment grade by another, we have to take the lower rating in terms of SVO, NAIC purposes, and in terms of our calculation of risk-based capital.

Steven Schwartz – Raymond James

So, a nationally adopted rule. It’s just not something that pertains to your domestic state?

Chris Wilkos

No.

Steven Schwartz – Raymond James

Okay. All right, thank you.

Operator

Thank you. This concludes the question-and-answer session. I’d now like to turn the call back to Mr. Wehr.

Jim Wehr

Thank you. Well, we’d like to thank everybody for their time and attention today. And that will wrap things up. Thank you very much.

Operator

This concludes today’s conference. Thank you so much for joining. You may disconnect at this time.

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Source: The Phoenix Companies, Inc. Q1 2009 Earnings Call Transcript
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